Archive for the ‘hedge funds’ Category

Hedge Funds Basics

August 2, 2007

I came across this useful paper on hedge funds. It is very basic and explains number of financial concepts as we go along reading the paper.

Its central idea is that financial markets involve risk. To mitigate these risks the market participants should do counterparty risk management properly. And this is still the best weapon against hedge funds, which are often criticised for posing high risks on the system. 

What are hedge funds? Hedge funds are private unregulated pools of capital.

How are they different from other money management funds?
1) They can invest in all kinds of assets and are flexible in their positions.
2) Use leverage liberally , as they are unregulated
3) Opaque to outsiders , again because they are unregulated
4) 2 and 20 pay structure for fund managers.

Now, first 3 make hedge funds different but not unique. For instance, we have mutual funds that do shortselling, Real Estate Investment Trusts etc. Leverage and opacity is common with most financial intermediaries when compared with other non-financial firms.

Fourth point makes hedge fund managers unique and the industry to work for. However, some funds do have things like hurdle rates (no incentive fee if returns are below the hurdle rate) and watermarks (incentive fee only on new profits).

Hedge Funds are often criticised for creating systemic risk. But what does it mean?

In our view, an essential feature of systemic risk is when financial shocks have the potential to lead to substantial, adverse effects on the real economy, e.g., a reduction in productive investment due to the reduction in credit provision or a destabilization of economic activity.

Indeed, it is the transmission of financial events to the real economy that is the defining feature of a systemic crisis, and which distinguishes it from a purely financial event. As discussed in more detail below, these real effects might occur if credit provision is interrupted through shocks to the banking sector or through capital market disruptions.

This is simplicity at its best.

The paper says as stable financial markets are like public goods.  As it is the case with Public Goods, everybody needs them but nobody wants to provide them. And we have problems of free-riding etc.

While, in principle, every bank should monitor its exposure and limit excess risk-taking by the hedge fund, each bank also has an incentive to free-ride by reducing its CCRM and enjoying the benefits of the CCRM of the other banks. This is a classic example of “tragedy of the commons” where private markets may under-provide the public good and create a rationale for official sector intervention.

So you need regulation, as private sector may not do the needful risk management properly. Simple ideas but conveyed pretty effectively.

Read it to revise issues like moral hazard, externalities, agency problems etc.

A nice, simple, effective read.

Assorted Links

April 30, 2007

I realised today morning that blogger has been banned in the office. Hence have shifted to wordpress which is quite decent but I liked blogger better.

It was a nice weekend. Alumni meeting on Saturday and a wedding on Sunday. Hence could not read much but here are some good links I read today morning:

1. A debate on effects of trade: There is a ferocious debate on the bolgosphere by some prominent economists on the effects of trade on the economy. It was started by Dani Rodrik and since then has been commented by economists including Mankiw, Krugman etc. Read about a summary of the debate here and here I would post my commnets on the same after understanding the whole idea.

2. More On Hedge Funds Fees

3. In US, Institutional Investors are now looking incrasingly at public infrastructure. An interesting story here

4. Have Chinese Scholars been bought?

5. Gender bias in Tariffs?

Update: Read this stirring speech by Mani Shankar Aiyar. We all know it is true but for it to come from a Cabinet Minister tells me that all is not lost in our country and we have some hope left.

Assorted Links

April 27, 2007
  1. A super speech by Fed Governor Mishkin on Globalisation and Financial Development. He also talks about the role of institutions in financial development, the topics I had blogged on previously (here and here) He is one of my favourite economists. His papers are one of the simplest to read.
  2. On Hedge Funds (By Brad De Long) . On Hedge Fund salaries.
  3. A good review of Susan Athey’s work (mentioned in previous post). Here is David Warsh praising her work. Here is Economist Profiling her work
  4. Lee Iacocca Interview .
  5. Diary of an Investment Banker. How little money they make?
  6. Contronyms?? Find out for yourself

Thanks to Marginal Revolution for 2 (1) & 6, Finance Professor for 2(2), 4 & 5 and New Economist for 3

Assorted Links…mostly Hedge Funds (25 Apr 2007)

April 25, 2007

Read this about Hedge Fund pay packets (From FT)

The combined earnings of the world’s top 25 hedge fund managers of more than $14bn (£7.49bn) exceeded the national income of Jordan last year and 3 individuals took home more than $1bn, according to the biggest annual industry survey.

The survey by Alpha Magazine put Jim Simons of Renaissance Technologies on earnings of $1.7bn, Ken Griffin of Citadel Investment Group on $1.4bn and Eddie Lampert of ESL Investments on $1.3bn. The previous year, two managers, Mr Simons and the septuagenarian T Boone Pickens of BP Capital Management, topped the $1bn mark.

  1. An excellent series of articles on Hedge Funds
  2. Read this good blog entry on Why is the top one percent earning more?
  3. Hedge Fund – a billion dollar club
  4. Return of the idiot ( a nice article on Latin America)

Thanks to Marginal Revolution for (3) and to Ajay Shah for (4)