Tail risk analysis needs preparation

As general rule, the most successful man in life is the man who has the best information.

Benjamin Disraeli

Ian Bremmer in his new book, The Fat Tail: The Power of Political Knowledge for Strategic Investing discusses the current greatest risks:

• Geopolitical risks because the focus has been on domestic economics.
• The new capitals of capital because wealth and money is shifting away from the West.
• Political instability from the current global economic crisis. The economic risks will turn political.

Tail risk was also discussed by one of the leading researchers a PIMCO. They make the important point that hedging tail risk after a crisis is of course too late. Just in time risk management is expensive and does not solve the problem so the the most important issue is trying to find the next tail event. This tail events do not have to be only downside risk or left hand tail events. There can be positive tail risks such as the large move in the stick market. Those we do not anticipate these types of big events may negatively affect their performance through missing opportunities.

The best way to avoid tail risk is through having the best information, but data is not enough. The information has to be processed to anticipate what may happen in the extreme. This requires scenario analysis of what may happen in an unconventional manner or at an inappropriate time. For a global investor, this is the geopolitical risk of a fall-out from a deep recession.