Managerial Methods to Control the Downside Risk of Derivatives

Abstract

Derivatives are at the very heart of the recent financial disasters, and the surveillance of their downside risk is of paramount importance both to practitioners and regulators. We survey and present original managerial methods to efficiently control the downside risk of derivatives portfolios. We first describe the managerial methods currently used in practice and their relative cost, and we then show that the most common methods actually aggravate this downside risk. We then argue that selecting appropriate underlyings satisfying some specific statistical and easily identifiable properties is a natural way to significantly reduce the downside risk without involving costly managerial interventions.