Over the past decades the architecture of the financial system has undergone a significant change, whereby the alternative investment industry has claimed an ever increasing importance and popularity. Hedge funds have taken the leading role in this development. From a handful of hedge fund managers in the United States (U.S.), hedge funds have been growing to a worldwide business at the forefront of sophisticated financial innovation. Despite their rising success in the alternative investment industry, only a few subjects in the financial world appear to create such diverse opinions as hedge funds do. On the one hand, there are policy makers and academics, which appreciate and highlight hedge funds’ main role in increasing profits and effectively diversifying risks in traditional portfolios. Moreover, Alan Greenspan, the former chairman of the Federal Reserve System (Fed), stated that hedge funds “have become major contributors to the flexibility of the financial system.” Provided with flexibility and light regulatory oversight, their participation in various markets has been proven important. Especially, due to the provision of liquidity, financial markets have become more efficient but also resilient by absorbing many financial shocks in past years, including the most recent financial crisis. On the other hand, there are also policy makers and academics, who claim that hedge funds are large enough to destabilize markets or even trigger financial crises. A common concern following the near failure of Long Term Capital Management (LTCM) in 1998 is that one single hedge fund, as a highly leveraged investment pool, can create systemic risk to the worldwide financial system. Such ongoing concern about the vulnerability paired with the tremendous development and opaque nature of hedge funds, emphasize their potential threat to financial stability. Despite the fact that only little is known about these loosely regulated private investment pools, an unstudied reaction to 1998 is to regulate them. Against this background, the aim of this paper is to give the reader a better oversight and understanding of the hedge fund industry by deeply analyzing and discussing their beneficial characteristics but more importantly the issue of how they may be an essential threat to the financial system. Therefore, the paper is split into four main parts. The first part provides the reader with an overall picture of the unfolding of the hedge fund industry from the beginnings...
Inhaltsverzeichnis (Table of Contents)
- INTRODUCTION
- LIMITATIONS OF APPLIED DATA
- DEVELOPMENT OF THE HEDGE FUND INDUSTRY
- DISTINGUISHING HEDGE FUNDS FROM OTHER INVESTMENT VEHICLES
- REGULATION AND SUBSCRIPTION
- INVESTMENT TECHNIQUES AND LEVERAGE
- OPACITY
- COMPENSATION STRUCTURE
- HEDGE FUND STRATEGIES
- DIRECTIONAL
- MARKET NEUTRAL
- EVENT DRIVEN
- MULTI STRATEGY
- POTENTIAL BENEFITS FOR THE FINANCIAL SYSTEM
- RISK DIVERSIFICATION
- RISK SHARING
- PROVIDERS OF MARKET LIQUIDITY AND EFFICIENCY
- HEDGE FUNDS' ROLE IN RISING MARKETS
- HEDGE FUNDS' ROLE IN FALLING MARKETS
- POTENTIAL RISKS FOR THE FINANCIAL SYSTEM
- MICRO-PRUDENTIAL RISK
- OPERATIONAL PROCESSES
- Operational Infrastructure
- Fraudulent Behavior
- INVESTOR PROTECTION
- OPERATIONAL PROCESSES
- MACRO-PRUDENTIAL RISK
- DIRECT TRANSMISSION CHANNEL
- Implications of Leverage
- Funding and Instrument Leverage
- Leverage and LTCM
- Development of Leverage from the Russian Default until 2011
- Systemic Relevance of Leverage
- Implications of Counterparty Credit Risk
- Counterparty Credit Risk Management
- Limitations of Counterparty Credit Risk Management
- Systemic Relevance of Counterparty Credit Risk
- Implications of Leverage
- INDIRECT TRANSMISSION CHANNEL
- Implications of Liquidity Risk
- Iliquidity Exposure
- Funding Liquidity Risk from Investor Redemptions
- Funding Liquidity Risk from Financiers
- Systemic Relevance of Liquidity Risk
- Implications of Connectedness Risk
- Empirical Evidence of Connectedness
- Systemic Relevance of Connectedness Risk
- Implications of Liquidity Risk
- SYSTEMICALLY IMPORTANT MARKETS
- DIRECT TRANSMISSION CHANNEL
- APPROACHES FOR REGULATION
- DIRECT REGULATION
- INDIRECT REGULATION
- CAPITAL MARKETS SAFETY BOARD
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
This master's thesis explores the impact of hedge funds on financial stability, specifically examining the implications for systemic risk and how to control for it. It aims to provide a comprehensive analysis of the hedge fund industry, its unique features, and its potential benefits and risks. Key themes include:- The evolving role and impact of hedge funds within the financial system.
- The inherent risks associated with hedge fund activities, particularly leverage and counterparty credit risk.
- The potential for hedge funds to contribute to systemic risk and financial instability.
- The need for effective regulation and oversight to mitigate the risks posed by hedge funds.
- Exploring various approaches to hedge fund regulation, both direct and indirect.
Zusammenfassung der Kapitel (Chapter Summaries)
- This chapter provides a comprehensive overview of the thesis, outlining the key research questions and objectives. It sets the stage for the subsequent chapters, which delve into the complexities of hedge funds and their impact on financial stability.
- This chapter explores the limitations of the data used in the analysis, acknowledging the inherent challenges of gathering and analyzing data related to hedge funds, especially their opaque nature.
- This chapter delves into the evolution of the hedge fund industry, tracing its growth and development over time. It highlights the key factors that have contributed to its expansion and the increasing influence it wields in the financial markets.
- This chapter examines the distinct characteristics that differentiate hedge funds from other investment vehicles, highlighting their unique features such as regulation and subscription, investment techniques, leverage, opacity, and compensation structures.
- This chapter explores various hedge fund strategies, providing a detailed overview of different approaches employed by hedge fund managers. It categorizes strategies into directional, market-neutral, event-driven, and multi-strategy, shedding light on the diverse investment approaches employed by hedge funds.
- This chapter analyzes the potential benefits that hedge funds bring to the financial system, examining their role in risk diversification, risk sharing, and providing market liquidity and efficiency. It explores how hedge funds can contribute to market stability and facilitate efficient allocation of capital.
- This chapter focuses on the potential risks that hedge funds pose to the financial system. It explores both micro-prudential risks, such as operational processes and investor protection, as well as macro-prudential risks, particularly those arising from leverage, counterparty credit risk, and liquidity risk. The chapter highlights the potential for hedge funds to contribute to systemic risk and financial instability.
Schlüsselwörter (Keywords)
This research focuses on hedge funds, financial stability, systemic risk, leverage, counterparty credit risk, liquidity risk, regulation, and the financial system. It explores the potential impact of hedge funds on market stability and the need for effective regulatory frameworks to mitigate associated risks. - MICRO-PRUDENTIAL RISK
- Quote paper
- Dennis Sauert (Author), 2011, Hedge funds and their impact on financial stability. Implications for systemic risk and how to control for it, Munich, GRIN Verlag, https://www.grin.com/document/275415
