26.07.2022 / 08:08
Long-Term Capital Management (LTCM)
Hedge fund Long-Term Capital Management (LTCM) had all the ingredients to be the star of Wall Street: one of the most successful traders like John Meriwether, famous Nobel Prize winners - Myron Scholes and Robert Merton, and significant initial capital.
After the Asian crisis and Russian default on bonds and currency devaluation, flight-to-quality and liquidity in 1998 together with the high leveraged strategy of the fund, made it almost collapse. LTCM in 1997 managed around $7 billion when in September of 1998 this amount dropped to $600 million. As LTCM by the mid of 1998 was too big to fail, the Federal Reserve Bank of New York arranged a bailout of the fund, by banks that could be affected by the very likely collapse.
The numerous takeaways especially for risk management could be identified in aftermath of this story:
Legal Regulations should cover more financial institutions despite the number of their investors and their net worth
Models should have as input long enough historical data and their output should be taken deliberately and correctly interpreted
Limitations and assumptions of the models should be considered (for example prices are not always reflecting economic changes immediately)
Better stress-testing and "worst scenario" analysis
Different types of risks should be considered