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Hedge Funds and the Collapse of Long-Term Capital Management

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  • Franklin R. Edward
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    Abstract

    The Fed-engineered rescue of Long-Term Capital Management (LTCM) in September 1998 set off alarms throughout financial markets about the activities of hedge funds and the stability of financial markets in general. With only $4.8 billion in equity, LTCM managed to leverage itself to the hilt by borrowing more than $125 billion from banks and securities firms and entering into derivatives contracts totaling more than $1 trillion (notional). When LTCM's speculations went sour in the summer of 1998, the impending liquidation of LTCM's portfolio threatened to destabilize financial markets throughout the world. Public policy response to LTCM should focus on risks of systemic fragility and ways in which bank regulation can be improved.

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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.13.2.189
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    Bibliographic Info

    Article provided by American Economic Association in its journal Journal of Economic Perspectives.

    Volume (Year): 13 (1999)
    Issue (Month): 2 (Spring)
    Pages: 189-210

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    Handle: RePEc:aea:jecper:v:13:y:1999:i:2:p:189-210

    Note: DOI: 10.1257/jep.13.2.189
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    1. Sanjiv Ranjan Das & Rangarajan K. Sundaram, 1998. "On the Regulation of Fee Structures in Mutual Funds," NBER Working Papers 6639, National Bureau of Economic Research, Inc.
    2. Stephen Brown & William Goetzmann & James Park, 1998. "Conditions for Survival: Changing Risk and the Performance of Hedge Fund Managers and CTAs," Yale School of Management Working Papers ysm83, Yale School of Management, revised 01 Apr 2008.
    3. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June.
    4. William N. Goetzmann & Jonathan E. Ingersoll, Jr. & Stephen A. Ross, 2004. "High Water Marks," Yale School of Management Working Papers ysm22, Yale School of Management.
    5. Fung, William & Hsieh, David A, 1997. "Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 275-302.
    6. Summers, L.H. & Summers, V.P., 1989. "When Financial Markets Work Too Well : A Cautious Case For A Securities Transactions Tax," Papers t12, Columbia - Center for Futures Markets.
    7. Stiglitz, J.E., 1989. "Using Tax Policy To Curb Speculative Short-Term Trading," Papers t2, Columbia - Center for Futures Markets.
    8. Chevalier, J. & Ellison, G., 1996. "Risk Taking by Mutual Funds as a Response to Incentives," Working papers 96-3, Massachusetts Institute of Technology (MIT), Department of Economics.
    9. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
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