Hedge funds and their impact on financial stability. Implications for systemic risk and how to control for it

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
  • 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
    • 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
    • SYSTEMICALLY IMPORTANT MARKETS
  • 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.

  Frequently Asked Questions

  What are the main benefits of hedge funds for the financial system?

  Hedge funds provide market liquidity, aid in risk diversification, and contribute to price efficiency by absorbing financial shocks.

  How can hedge funds pose a systemic risk?

  Due to high leverage and interconnectedness with large banks, the failure of a single large fund (like LTCM in 1998) can destabilize the global financial system.

  What is "leverage" in the context of hedge funds?

  Leverage refers to using borrowed money to increase the potential return on an investment, which also significantly increases the risk of loss.

  Why are hedge funds often described as "opaque"?

  They are subject to less regulatory oversight and disclosure requirements than mutual funds, making their specific strategies and holdings less transparent to the public.

  What is the difference between direct and indirect regulation?

  Direct regulation targets the funds themselves, while indirect regulation focuses on the banks and prime brokers that provide credit to the funds.