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

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  • King, Michael R.
  • Maier, Philipp

Abstract

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.

Suggested Citation

  • King, Michael R. & Maier, Philipp, 2009. "Hedge funds and financial stability: Regulating prime brokers will mitigate systemic risks," Journal of Financial Stability, Elsevier, vol. 5(3), pages 283-297, September.
  • Handle: RePEc:eee:finsta:v:5:y:2009:i:3:p:283-297
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    References listed on IDEAS

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    1. Allen, William A. & Wood, Geoffrey, 2006. "Defining and achieving financial stability," Journal of Financial Stability, Elsevier, pages 152-172.
    2. Patrick M McGuire & Kostas Tsatsaronis, 2008. "Estimating hedge fund leverage," BIS Working Papers 260, Bank for International Settlements.
    3. Tomas Garbaravicius & Frank Dierick, 2005. "Hedge funds and their implications for financial stability," Occasional Paper Series 34, European Central Bank.
    4. Danielsson, Jon & Taylor, Ashley & Zigrand, Jean-Pierre, 2005. "Highwaymen or heroes: Should hedge funds be regulated?: A survey," Journal of Financial Stability, Elsevier, pages 522-543.
    5. Hott, Christian, 2009. "Herding behavior in asset markets," Journal of Financial Stability, Elsevier, pages 35-56.
    6. 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.
    7. 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.
    8. repec:fip:fedgsq:y:2006:i:may12 is not listed on IDEAS
    9. Garbaravicius, Tomas & Dierick, Frank, 2005. "Hedge funds and their implications for financial stability," Occasional Paper Series 34, European Central Bank.
    10. Allen, William A. & Wood, Geoffrey, 2006. "Defining and achieving financial stability," Journal of Financial Stability, Elsevier, pages 152-172.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Bengtsson, E., 2013. "Fund Management and Systemic Risk - Lessons from the Global Financial Crisis," CITYPERC Working Paper Series 2013-06, Department of International Politics, City University London.
    2. Monica Billio & Mila Getmansky & Andrew W. Lo & Loriana Pelizzon, 2010. "Econometric Measures of Systemic Risk in the Finance and Insurance Sectors," NBER Chapters,in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
    3. Dimitrios Bisias & Mark Flood & Andrew W. Lo & Stavros Valavanis, 2012. "A Survey of Systemic Risk Analytics," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 255-296, October.
    4. Adams, Zeno & Füss, Roland & Gropp, Reint, 2014. "Spillover Effects among Financial Institutions: A State-Dependent Sensitivity Value-at-Risk Approach," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 49(03), pages 575-598, June.
    5. Robert Hull & Sungkyu Kwak & Rosemary Walker, 2014. "Hedge fund attributes and volatility around equity offerings," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 38(3), pages 359-382, July.
    6. Gerhard Wörtche & Tristan Nguyen, 2011. "The impact of M&A transactions from private equity and hedge funds: Empirical evidence from Austria and Switzerland," Journal of Financial Regulation and Compliance, Emerald Group Publishing, vol. 19(1), pages 45-57, February.
    7. VanHoose, David, 2011. "Systemic Risk and Macroprudential Bank Regulation: A Critical Appraisal," Journal of Financial Transformation, Capco Institute, vol. 33, pages 45-60.
    8. Patro, Dilip K. & Qi, Min & Sun, Xian, 2013. "A simple indicator of systemic risk," Journal of Financial Stability, Elsevier, pages 105-116.
    9. repec:eee:empfin:v:42:y:2017:i:c:p:109-130 is not listed on IDEAS
    10. Silva, Walmir & Kimura, Herbert & Sobreiro, Vinicius Amorim, 2017. "An analysis of the literature on systemic financial risk: A survey," Journal of Financial Stability, Elsevier, pages 91-114.

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