A risk profile shows the probability densities that correspond to each possible profit or loss level.
The green line corresponds to the risk profile of a atypical diversified portfolio.
The red line corresponds to the same risk profile, but after applying a hedging strategy.
The red profile is typical for a hedged portfolio. One can see that
- The losses are now limited, they cannot be greater than 2.5%
However, despite the hedge, losses are still possible. This results, among others, from the costs of acquiring the hedging instruments.
- Some profits have now a higher probability density than before the
hedge. However, the interval for which this is true strongly depends on the type of hedging instruments that are used.