Monday, November 10, 2008

Making Common Sense out of Common things in Finance

Risk
Main risk to consider is downside volatility

Risk adjusted rewards
Intuitive reward to risk ratio: mean(returns) * SD(Upside Risk) / V(Downside Risk)
NB: without adjustment to skew and kurtosis

Hedging error
Many talk about minimising hedging error. But what makes sense is minimising the downside due to the hedging error and maximise the upside hedging error. The upside hedging error can be maximised by holding a long Gamma position.

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