Texas Hedge

My kickoff reaction to the JP Morgan loss was, if their "hedge operation" had expire a "profit center" equally reported, nosotros know just what went wrong. (And, if they weren't playing alongside a authorities guarantee, who would attention if they lost $2 billion in addition to around hedge funds gained $ ii billion?)

Andy Lo position it beautifully:

Yes, nosotros tin compass the divergence [between hedging in addition to trading]....There is 1 rattling unproblematic interrogation that you lot tin inquire — which has a definitive reply — nigh the modest release of individuals who were responsible for managing this grouping at JP Morgan in addition to putting on the specific trades that lost these large amounts of money. That interrogation is: How were they compensated on an annual basis? Were they paid a salary in addition to a bonus, in addition to was the bonus a part of the profitability of the group, or was the bonus a part of the hedging mightiness of the group? If you lot tin reply this interrogation — in addition to it definitely has an reply to it; it’s non a metaphysical interrogation — you lot volition accept your reply equally to whether it was proprietary trading or hedging. I don’t know the answer, only I know the reply exists, in addition to I know that sure enough the authorities tin instruct that reply alongside a unmarried telephone call. 

Hedging is supposed to lose coin when everyone else makes money. That tin travel measured. The risks of the entire bank, which hedgers are supposed to minimize, tin travel measured.

I mean value Andy knows the reply to this question. I suspect I practise too, only possibly I'm existence likewise cynical.

(Thanks for pointer from Arnold Kling)