Magazine article Regional Economist

Even Nobel Laureates Can Be Tripped Up by Uncertainty

Magazine article Regional Economist

Even Nobel Laureates Can Be Tripped Up by Uncertainty

Article excerpt

Long-Term Capital Management (LTCM) was a hedge fund known for the extraordinary talent of its traders and research staff. Among the partners of LTCM were Robert Merton and Myron Scholes, who share the 1997 Nobel Prize in Economics for their work on securities pricing. Merton said that LTCM "attempted to marry the best of finance theory with the best of finance practice," recounted Roger Lowenstein in his 2000 book, When Genius Failed: The Rise and Fall of Long-Term Capital Management.

Hedge funds try to profit from temporary market inefficiencies that manifest themselves in securities mispricing. By owning comparatively underpriced securities and owing comparatively overpriced securities, hedge funds record capital gains when the price difference (spread) between the two securities narrows. Lowenstein recounts Myron Scholes explaining LTCM's trading strategy as "earning a tiny spread on each of thousands of trades, as if it were vacuuming up nickels that others couldn't see." Within four years, a dollar invested in the hedge fund quadrupled. To generate such high return on tiny spreads, LTCM put on very aggressive trades.

In the summer of 1998, in the wake of the Russian default on ruble-denominated debt, LTCM blew up rather spectacularly. In fact, LTCM pushed the world financial system to the brink of collapse when its liquidity dwindled and large hedge portfolios in securities markets around the world were on the verge of being closed out in a fire sale. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.