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Risk Management Lessons from Madoff Fraud

Author

Listed:
  • Clauss, Pierre
  • Roncalli, Thierry
  • Weisang, Guillaume

Abstract

In December 2008, as the nancial and economic crisis continued on its devastating course, a new scandal erupted. After the 1998's failure of Long-Term Capital Management, Madoff's fraud once again discredits the hedge funds industry. This scandal is however of a dierent kind. Indeed, Madoff's rm is not a standard hedge fund but a developed Ponzi scheme. By explaining Madoff's system and exploring the reasons for its collapse, this paper draws risk management lessons from this fraud, especially for operational risk management. Present day risk management processes have partially failed to prevent the Madoff scandal. This paper presents the issues for risk capital requirements raised by the collapse of the Madoff scheme. Implications for due diligence processes, including the use of quantitative replication to assess the credibility of the performance of a hedge fund, are also considered. Finally, consideration is given to the regulatory and standardizing approaches of the hedge fund industry as a response to frauds similar to that of Madoff.

Suggested Citation

  • Clauss, Pierre & Roncalli, Thierry & Weisang, Guillaume, 2009. "Risk Management Lessons from Madoff Fraud," MPRA Paper 36754, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:36754
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    References listed on IDEAS

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    Cited by:

    1. Philippe Bernard & Najat El Mekkaoui De Freitas & Bertrand B. Maillet, 2022. "A financial fraud detection indicator for investors: an IDeA," Annals of Operations Research, Springer, vol. 313(2), pages 809-832, June.

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    More about this item

    Keywords

    Madoff fraud; Ponzi scheme; operational risk; due diligence; supervision; hedge funds; bull spread strategy; split strike conversion;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services

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