Managing Hedge Fund Risk and Financing: Adapting to a New Era

Conclusion

A hedge fund's investment risk cannot be managed in isolation from the overall business risks. The loss-minimizing actions of prime brokers seeking to protect the money they have lent, the redemption activity of investors seeking to preserve their principal, and the incentives of staff seeking to preserve their net worth, track record, and businesses, all directly affect the ability of a fund to manage its risks in a crisis. The majority of hedge funds don't have a risk manager. Even those that do, typically divide investment-risk management assigned to the risk manager or portfolio manager from the business risk management of the fund managed by the CFO. Optimizing the management of a hedge fund's total business risks is the focus of the remainder of this book.

Endnotes

1. Black Monday was Monday, October 19, 1987 when the S&P 500 Index lost 20.5 percent and the Dow Jones Industrial Average lost 22.6 percent.

2. In 1987, there were only five daily moves greater or equal to 5 percent.

3. A Prisoner's Dilemma is a term common in game theory which is characterized as a situation where collective losses are minimized or collective gains are maximized through cooperation, while individual losses are minimized or individual gains are maximized by self-serving action. The name describes the situation of prisoners who, given their greater numbers, could easily overpower their guards and escape if they cooperated but who don't to do so because potential individual loss (death) ...