From the options-hedging practice of institutional finance, with the fat-tail case named by Nassim Nicholas Taleb (The Black Swan, 2007) and set out by Mark Spitznagel (Safe Haven, 2021).
Protects against rare catastrophes by paying a small, steady cost for positions or arrangements that pay off heavily in disaster, then checks they hold when everything fails together.
When to reach for it
A low-probability event that would be ruinous, in the same scenario where ordinary diversification or insurance would fail.
How it runs
- List the rare events that would be catastrophic.
- Estimate roughly how bad each would be.
- Find hedges that pay off in those scenarios.
- Check that each hedge still works when correlations spike.
- Price the ongoing cost and set a budget for it.
- Put the hedges in place before events, never after.
Where it sits in SOLVE eX
Go to the source
- The Black Swan, Random House, 2007
- Safe Haven: Investing for Financial Storms, Wiley, 2021