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Guys, I would like to start a thread on what would be the most optimal hedging strategy of bespoke tranches. Assuming we have a 125 names with equal diversity as the Itrax European names. And we have a model that gives an accurate measure of risk for the underlying names. In my opining hedging using the single names is too expensive (bid/ask), we can use Itrax index europe to hedge our default risk however we cannot rely on Itrax index to hedge our correlation risk. We can use a dynamic hedge for example if we are selling protection on an equity tranche we can apply a hedge by going long (buying protection) on Itrax tranche 0-3% if the underlying tranche happens to be a 0-3%, since most houses are still relying on base correlation to calibrate bespoke this might be a good hedge. Please guys let me know what u think

But there will be mismatch since the itrax underlying may be different from that in your bespoke tranche.But at least, it hedges the correlatin exposure (like back-to-back trade)any opinion from others ? I am not a trader, so what I said could be wrong.

venom,just want to catch up with you. Can you tell me what the definition of bespoke tranches is? Sometimes I am confused about this.

Isn't the problem that the bespoke tranche (meaning different portfolio here -- it can also mean off-the-run strikes and maturities) might have a correlation behavior that is different from the index? For first order large correlation moves, then they should track OK. But what if the bespoke pool has a slight over-concentration in a couple of industry sectors, unlike the index, and these two sectors start ailing. Then the shape of the base skew should start diverging quite a bit. How can one hedge that, and simpler yet, even quantify how different the two pools are?

A bespoke tranche is a tranche specified by the buyer which differs from the standard iTraxx tranches...as shown below0-3% Equity tranche3-6% Junior Mezz6-9% Senior Mezz9-12% Senior12-20% Super seniorIf i wanted exposure to say 2-5% (a bespoke tranche) notional of defaults, then this is likely to be fairly illiquid and not well traded.James

The common terminology is to refer to tranches with a non-standard reference pool composition as "bespoke", while tranches of the standartized iTraxx or CDX portfolios are referred to as "non-standard" tranches.