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Hedge funds and financial stability: Regulating prime brokers will mitigate systemic risks

  • King, Michael R.
  • Maier, Philipp

We review key characteristics of the hedge fund industry, and identify conditions under which this sector can pose a threat to financial stability. Direct regulation of hedge funds that increases transparency does not appear feasible, may create a moral-hazard problem, and may reduce market liquidity. Indirect regulation by prime brokers and market discipline by creditors, counterparties, and investors have been effective in limiting the risks from the hedge fund sector. To reduce systemic risks, more regulation of prime brokers is warranted to avoid competitive dynamics from undermining counterparty risk management practices.

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

Volume (Year): 5 (2009)
Issue (Month): 3 (September)
Pages: 283-297

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Handle: RePEc:eee:finsta:v:5:y:2009:i:3:p:283-297
Contact details of provider: Web page: http://www.elsevier.com/locate/jfstabil

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  1. Danielsson, Jon & Taylor, Ashley & Zigrand, Jean-Pierre, 2005. "Highwaymen or heroes: Should hedge funds be regulated?: A survey," Journal of Financial Stability, Elsevier, vol. 1(4), pages 522-543, October.
  2. Nicholas Chan & Mila Getmansky & Shane M. Haas & Andrew W. Lo, 2007. "Systemic Risk and Hedge Funds," NBER Chapters, in: The Risks of Financial Institutions, pages 235-338 National Bureau of Economic Research, Inc.
  3. Hott, Christian, 2009. "Herding behavior in asset markets," Journal of Financial Stability, Elsevier, vol. 5(1), pages 35-56, January.
  4. Tomas Garbaravicius & Frank Dierick, 2005. "Hedge funds and their implications for financial stability," Occasional Paper Series 34, European Central Bank.
  5. Patrick M McGuire & Kostas Tsatsaronis, 2008. "Estimating hedge fund leverage," BIS Working Papers 260, Bank for International Settlements.
  6. 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.
  7. Allen, William A. & Wood, Geoffrey, 2006. "Defining and achieving financial stability," Journal of Financial Stability, Elsevier, vol. 2(2), pages 152-172, June.
  8. repec:fip:fedgsq:y:2006:i:may12 is not listed on IDEAS
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