Over-Hedging And Double-Counted Risk
A practical hedging mistake where overlapping hedges or misread exposures cause a desk to hedge the same risk twice, leaving it net short the very thing it meant to protect.
Prerequisites: Delta Hedging Frequency And Costs
Over-hedging happens when a desk hedges an exposure it has already partially or fully offset elsewhere, without noticing the overlap. It's easy to picture: a trader holds a stock position and buys index futures to hedge market risk, and separately hedges sector risk with a sector ETF short. If the stock position and the sector short both move opposite the same underlying exposure, and nobody re-checks the combined position, the desk can end up net short the market it originally wanted to be neutral on — the two hedges didn't just overlap, they stacked and overshot.
The double-counting usually comes from organizational blind spots rather than bad models: separate risk systems computing exposure at the position level without netting across books, a hedge put on by one desk that unknowingly duplicates a hedge already carried by another desk trading a correlated instrument, or a risk report that shows gross hedge notional without showing what it nets to against the underlying book. Each hedge looks correct in isolation; the mistake only appears once exposures are aggregated across the whole portfolio.
The fix is structural rather than mathematical: maintain a single source of truth for net exposure by risk factor (not by desk or instrument), and re-check it every time a new hedge is proposed, rather than trusting that each hedge is independently sized correctly. Firms that split hedging across multiple books are the most exposed to this failure, because no single trader sees the full picture.
A hedge that looks correct in isolation can still be wrong in aggregate — always check net exposure across the whole book, not each hedge on its own.
Further reading
- Taleb, Dynamic Hedging, ch. 2