Guest whitepaper by Sashank Narasimhadevara, Macro Credit Fund Manager & Alexei Tchernitser, Director, Product Management, Quantifi.
This paper aims to uncover the misleading and often counter-productive nature of using gross notionals or gross market value in a credit derivatives book. It further proposes alternative approaches that provide a much more appropriate representation of the risk, exposure and leverage of a fund that utilises these products. These approaches are intuitive and easily accessible with the right analytical tools.
Gross notionals are a popular and superficially tractable way for allocators to measure a fund’s leverage, particularly in the long/short equity and the long/short credit space. The genesis of the measure stems from the perspective of a long-short equity fund. Grossing up long and short notionals provides a measure of the potential loss the fund is exposed to (assuming a short position doubles in price).
As a result, allocators have seemingly extended this approach to long/short credit and further to credit derivative-based products. This paper goes to show why this is not only inappropriate, but a misleading measure of a credit derivative book’s risk.
Contents
- Risk and leverage in hedge fund strategies
- Exploring credit derivative books
- Towards a comprehensive risk assessment
