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Leveraged investor disclosures and concentrations of risk

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  • Ko, K. Jeremy
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    Abstract

    We analyze a model where investors (e.g., hedge funds) need to borrow from lenders with heterogeneous risk-exposures and risk-management motives. Investors may obtain advantageous terms of borrowing by disclosing their investment strategy, thereby revealing its correlation to the lender's existing risk exposure. Investors risk being "front-run" by their lender if they disclose, however. We show that in the presence of front-running, the "unraveling" result of full disclosure may not hold. In addition, disclosure regulation results in a loss of welfare since investors compelled to disclose will mitigate front-running by choosing a lender with sufficiently high correlation, thus exacerbating concentrations of risk.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Markets.

    Volume (Year): 12 (2009)
    Issue (Month): 3 (August)
    Pages: 368-390

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    Handle: RePEc:eee:finmar:v:12:y:2009:i:3:p:368-390

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    Web page: http://www.elsevier.com/locate/finmar

    Related research

    Keywords: Hedge funds Disclosure Risk management Front-running Systemic risk;

    References

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    1. Yosha Oved, 1995. "Information Disclosure Costs and the Choice of Financing Source," Journal of Financial Intermediation, Elsevier, vol. 4(1), pages 3-20, January.
    2. Masako Ueda, 2004. "Banks versus Venture Capital: Project Evaluation, Screening, and Expropriation," Journal of Finance, American Finance Association, vol. 59(2), pages 601-621, 04.
    3. Campbell, Tim S., 1979. "Optimal Investment Financing Decisions and the Value of Confidentiality," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 14(05), pages 913-924, December.
    4. Franklin R. Edward, 1999. "Hedge Funds and the Collapse of Long-Term Capital Management," Journal of Economic Perspectives, American Economic Association, vol. 13(2), pages 189-210, Spring.
    5. Verrecchia, Robert E., 1983. "Discretionary disclosure," Journal of Accounting and Economics, Elsevier, vol. 5(1), pages 179-194, April.
    6. Paul R. Milgrom, 1979. "Good Nevs and Bad News: Representation Theorems and Applications," Discussion Papers 407R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    7. Bhattacharya, Sudipto & Ritter, Jay R, 1983. "Innovation and Communication: Signalling with Partial Disclosure," Review of Economic Studies, Wiley Blackwell, vol. 50(2), pages 331-46, April.
    8. Campbell, Tim S., 1979. "Abstract: Optimal Investment Financing Decisions and the Value of Confidentiality," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 14(04), pages 669-669, November.
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