General Introduction

Hedge funds are now one of the most popular in financial circles or in anything related to the broader economy. These funds, mysterious to the public, political, and many investors, are often described, without the accusations against them are targeted to be verified. This reflects a misunderstanding of the real mode of operation of hedge funds and their impact on the economy.

For nearly twenty years, issues related to the operation of hedge funds and their impact on markets and more generally on the financial systems are gradually a field of study in its own right, rich body of literature.

The term hedge fund means hedge funds. The latter appeared on 1 January 1949 when a certain Alfred W.Jones opened a formal background in action as a private company.

Its aim was to provide flexibility and maximum flexibility in the creation of a portfolio. To increase profitability while reducing risk exposure in the market, Mr. Jones took the positions of both buyer and seller, and had recourse to the leverage to increase the performance of the securities.

It is difficult to define what a hedge fund to the extent that there is no real definition, that is why we returned to the general definition of Capocci Daniel:

"A Hedge fund is a private investment using a wide range of financial instruments such as short selling of equities, derivatives, leverage, arbitrage, and this in different markets. Generally, the managers of these funds to invest part of their resources and are paid according to their performance. These funds often require high minimum investments and access is limited. They are particularly aimed at wealthy clients, whether private or institutional. "

There is a difference between hedge funds and mutual funds, they do not have the same characteristics as those of hedge funds. The two most notable differences concern risk management and the performance.

Indeed, hedge funds are much riskier than mutual funds, but this risk is paid according to performance of these funds, hedge funds are characterized by low regulation and transparency that makes them special and unique in their kind.The hedge fund industry is growing rapidly in recent years. Estimates of

Hedge Fund Research (HFR), from 610 funds managing $ 39 billion in assets in 1990, they had risen to 3,873 and funds managed $ 490 billion ten years later. At the end of the third quarter of 2006, 9,228 funds managed some 1 400 billion, representing an annualized growth of their assets by 19% since 2000. Of this total, over 1 000 billion are held by U.S. funds, 325 billion are managed in Europe and 115 billion in Asia (Ferguson and Laster, 2007).

Based on these impressive results can not be removed is a simple conclusion is that hedge funds play a large role in economic growth, and their profitability can be classified as a stabilizing factor of the financial system

But what is meant by financial stability? Mishkin defined it as " ... the prevalence of a Financial System Able to Ensure Which is in a lasting way, and without major disruptions, an efficient allocation of savings to Investment Opportunities. "

Ie that the prevalence of a financial system that is able to ensure a sustainable manner, and without major disruptions, an efficient allocation of savings to investment opportunities.

Indeed, this contribution is measured by injecting liquidity in large volumes, the price discovery and spread of risk that enhance the efficiency of financial markets and here we talk about hedge funds as a stabilizer system Financial.

On the other hand, we keep seeing reviews that accuse hedge funds of being propagators of crisis and financial instability, the least we can youIs that this is a subject ready to controversy. Especially after the last two crises, those of LTCM and the real estate, hedge funds were the first to blame for this and they are still considered as investment funds are very sophisticated and very speculative meaning they are attached to liquidity risk and systemic risk as a result, the hyphen is the hedge fund factors destabilizing financial markets.

In this regard will be developed in the following the following problem:

What is the impact of hedge funds on financial markets.

The answer to this question will be taken in two parts:

In the first chapter, we develop the contribution of hedge funds to see them as instruments of efficient markets.

In the second chapter will analyze the antithesis, the role of hedge funds as destabilizing the financial system.


I- Hedge fund market stabilizer:

Since the 90s, hedge funds have experienced a great attention from central bankers and supervisors with their role in the functioning of financial markets and this is due to growth in assets managed by these funds and the diversity of their strategies.

"The hedge fund industry has grown strongly and hedge funds have become an increasingly important diversification for investors and liquidity for the markets. The institutionalization and increasing customer sophistication of management and risk controls within the largest hedge funds have, in many ways, contributed make them important players in financial markets. "

(Draghi 2007, p.44)

Adaptation between the financial market and hedge funds is faite.En effect, must be recognition of the blessed formed by hedge funds on financial market efficiency (2007 Walnut)

The atypical nature of hedge funds has raised many questions about the consequences of their activity in financial markets. The positive roles that they attribute are relatively well identified. Thus it is accepted to participate, by the discovery of good equilibrium prices, greater market efficiency, they contribute importantly to provide liquidity, and finally they have developed the Credit derivatives allowing better risk sharing. (Meier and Nagel 2004).

But hedge funds vary greatly in size and their strategies. Any generalization about them seems difficult. The many improvements in market practice and supervision have allayed concerns about stability, but the increasing complexity of products and markets creates new challenges (Draghi 2007).

So, although they are considered the most risqu�set funds are also considered an innovation in the market; hedge funds have helped to ensure financial market stability.

In this chapter we will deal with hedge funds as stabilizing the financial market by presenting their contributions that have allowed this stability.


1 - Hedge Funds: F ournisseurs liquidity:

Liquidity is easier to recognize than to define. Basically, liquidity is the ease with which the value can be realized on assets. Value can be achieved either using its credit to obtain external financing or the sale of certain assets on the market.

There are two concepts of liquidity:

The first concept, the "funding liquidity" is the ability of financial institutions to perform their intermediation functions. Typically, a financial institution is a provider of liquidity, issuing liquid liabilities to hold less liquid assets, using its capital to cover the liquidity risk and take a ride on the provision of liquidity is justification cost of capital employed.

The second concept, "market liquidity" refers to the ability to make transactions in order to adjust portfolios and risk profiles without disturbing the underlying price.

The dimensions of market liquidity are:

� market "depth", or the ability to execute large transactions without influencing prices.

� "Rigor," or the gap between bid and ask prices.

� "Immediacy" or the speed with which transactions can be executed.

� "Resilience", or the speed with which the underlying price are restored after a disturbance (Crockett 2008).

Hedge funds are seen as stabilizing market as they improve the functioning of the market by providing liquidity.

Hedge funds have an active role in market liquidity. At first there must be agreement on the definition of so-called liquidity is highly context-dependent. Here it comes to financial products or liquidity of the market as a whole and not liquidity agents. It obviously not talking about liquidity in the banking sense, for example, refinancing agents in need of cash is not part of the activity of hedge funds even if they happen to be of service certainly on occasion.

A liquid asset is a financial product that can be turned into money with minimum loss of value. Generally, there also combines extremely short transaction times. A market is liquid when it says is capable of accommodating a high transaction volume without distorting prices. Indeed, when a market is experiencing a liquidity shock, asset prices tend to deviate from its fundamental value because agents have to bear a liquidity risk that just add to the intrinsic risk of the title.

The positive role requires investment funds in terms of liquidity is very intuitive, and often is highlighted by the most fervent defenders of lack of regulation. The very fact of adopting the majority of short positions in risky assets is in itself an argument. Indeed, hedge funds are not deemed to secure capital on long postions, which could affect market liquidity. In addition, they practice a particularly active portfolio management coupled with significant leverage. However, in view of the part of the transaction volume that represents hedge funds at the current time (King and Maier 2007), one can legitimately question the unquestionable character of this contribution.

The positive aspect of their work on liquidity is certainly limited to certain market segments where there is a very limited number of agents. The best example being the convertible bond market, which shows a structural undervaluation and without hedge funds would be subject to liquidity crises chronic (Agrawal, Fung and Naik 2007).

It is estimated that only such sophisticated investors are able to speak this type of market because of the complexity of products traded in them, especially in terms of hedging techniques that must be implemented. Owning a convertible in fact requires to cover not only interest rate risk and counterparty risk but also to changes in underlying prices. However, keep in mind that hedge funds represent in this market, representing 89% of transaction volume. Under this single figure, it seems clear that they play a role in the liquidity of convertible bonds as they do most of the market.

The argument, little justification in the literature, seems a bit low and would need to be more thoroughly substantiated by analyzing their role in other markets.

These funds are also active in developing new markets creating sufficient liquidity to enable traditional managers to follow. (Dubois and Mustier, 2007)

"When liquidity becomes scarce and other market participants avoid trade on a particular security, hedge funds often mingle in a negotiation that contributes to market liquidity, resulting in a reduction of risk premiums associated with assets Financial. This ultimately means a lower cost of capital "(Ferguson and Laster, 2007, p48).

When the market price of the currency strongly deviates from its fundamental value, hedge funds looking for opportunities to arbitrage the difference, thus promoting the return of asset prices from their fundamental values. Hedge funds are particularly able to act that way because their investors are generally subject to "lock up", who need to maintain their investments with the fund for a range of periods. Hedge funds have credit lines used in an investment opportunity (Ferguson and Laster 2007).


2- Hedge F unds: The discovery of a good equilibrium prices and greater market efficiency:

Despite concerns about the impact of hedge funds on market stability, it is important to recognize the potential beneficial impact of these media markets in which they operate. In principle, the introduction of a new group of actors on a financial market should increase the depth, breadth and liquidity of the latter. Hedge funds are sophisticated investors, often able to take a relatively long-term perspective. The nature of their customers allows them to temporarily take positions contrary to the general perception of the market, where developments affect the latter. Their presence can therefore facilitate the inclusion of new information into prices and stabilize market prices when transitory shocks.

In an efficient market, asset prices represent the fair value of a security, that is to say its ability to generate significant wealth over time. We generally associate the price misalignments to errors of anticipation when the fundamental agents for the title. These errors arise from information asymmetries that lead agents to adopt irrational behavior mimicry. The bad valuations of securities deceive investors leading to a misallocation of resources, potentially affecting the long-term growth.

The presence of investors fundamentalists practicing arbitration is therefore necessary for the proper functioning of markets. They base their positions on a detailed analysis of the fundamentals of a security or market and are therefore able to identify price misalignments. Their arbitrage strategy, which is to take short positions in overvalued securities and vice versa, helps to discover fair prices. Hence it is estimated that hedge funds, as investors sophisticated advantage of arbitrage opportunities, contribute to market efficiency.

Hedge funds play an essential role in the process of price discovery in many markets. Some trading days in 2005, hedge funds accounted for by some estimates about half the volume traded on the NYSE and the London Stock Exchange. In addition, the hedge fund industry has gained significant market share in trading volumes of debt instruments and derivatives.

Because of their flexibility and their speed of reaction, it is likely that hedge funds can play a role of additional indicator for other market participants, which could encourage herd behavior (Weber 2007).

Because hedge funds are not restricted in their choice of instruments (short-selling, for example), they can contribute to the process of price discovery using a variety of techniques to support their judgment. With their agility to adjust their exposure, all relevant information is fully and quickly reflected in market prices. In general, we can consider that hedge funds contribute to market completeness.

In addition, it may be that most hedge funds are able to correct anomalies in price, they leave less opportunities for profitable arbitrage. The hedge fund managers know that effective detect anomalies and exploit for their own account.

Others perceive the tactics and do the same, eventually (sometimes quite rapidly) by correcting anomalies. Thus, the strategy, once highly profitable, which was to exploit inconsistencies in rates between preferred and common shares is at the root of the rise and then collapse, a large number of funds established specifically to monitor this strategy (Crockett 2008).

So thanks to their flexible investment approach in financial markets and their extensive use of innovative financial instruments, hedge funds have contributed to the discovery of improved prices in financial markets. Makes price discovery more efficient financial market to allocate capital.


3 - H edge F undsDispersion and transfer of risk:

Demonstrate their critical role, the main traditional intermediaries in the financial sector (commercial banks and investment banks) take an increasing share of their profits they offer services to hedge funds. The business model of these intermediaries, based on which they pool and transfer more risk to others, would not have undergone such rapid development if hedge funds had not been active in risk takers and negotiators (Draghi 2007).

Some hedge funds have adopted practices effective risk management, internal control, disclosure / transparency and documentation and encouraged informal dialogue with the market authorities. These actions are encouraging. It is essential that these practices are growing in the hedge fund community (Draghi 2007).

Hedge funds have certainly played a large role in the development of credit derivatives allowing better risk sharing. Asset securitization gives banks the opportunity to leave a portion of the balance sheets of bad loans that would increase the risk of their portfolio. This technique has the main advantage of containing the growth in capital reserves they need to realize (Ferguson and Laster 2007).

These regulatory provisions are intended to guarantee the solvency of banks in case of default of borrowers and prevent bank failures and systemic crises that may arise. The securities credit can then transfer the counterparty risk associated with these high-risk loans into the financial markets. Hedge funds, are risk takers by nature, quickly rushed into the market guaranteeing high returns. From the perspective of the finance market as a whole, that is to say, banks and financial markets, these products have a better risk sharing between agents, which is one of the fundamental attributes of financial markets (Ferguson and Laster , 2007).

When the institutions that facilitate the sharing of risk, such as the equity markets, derivatives and insurance, are working properly, they transfer the risk to those most willing and better able to support them, which can promote the efficiency of an economy.

The risks can be moved to the parties most and best equipped to fulfill them. This helps the economy run more efficiently. Hedge funds have become an important source of venture capital. On a larger scale, hedge funds absorb credit risks of other financial institutions (Ferguson 2007).

Hedge funds have become an important source of venture capital. The emerging market securitization insured part (insurance linked securities) including integrating

-An increase in counterparty risk, the failure of an entity that could compromise the viability of its counterparties, thereby triggering a chain reaction.

Some are designed to invest exclusively in the insurance risk. Over time, insurers will increasingly appeal to hedge funds, which supplement the reinsurance in areas such as acute risk of disaster, for which insurers do not have enough funding. On a larger scale, hedge funds absorb credit risks of other financial institutions, including banks, which divides these exposures to a wider range of investors holding diversified portfolios (Ferguson and Laster2007).

Growth of assets managed by hedge funds and the increased diversity of their strategies reflect the importance of hedge funds on a large number of financial markets. It is interesting to note the role of providing liquidity and risk taker played by hedge funds in the dynamic markets of transfer of credit risk, which consist in particular of credit derivatives, bank loans on the secondary market and securitization transactions, like securities backed by mortgage-and other structured products.

Indicator of the increasing role played by hedge funds in the markets for credit risk transfer, the percentage of outstanding assets categorized in strategies that generally invest in securities indexed to credit risk rose from 6% in 1990 to 16% in 2006. Hedge funds are now investing in assets once widely held by banks in their lending activity (Cole, Feldberg, and Lynch 2007).

Risk sharing that hedge funds can enhance market stability. Assuming some of the increasing volume of credit and catastrophe risks in the marketplace alongside banks and insurers, hedge funds join other institutions acting as shock absorbers, which could limit the spread of damage from recessions credit crises and natural disasters. Hedge funds can help improve market stability in tumultuous times in other ways also. (Ferguson 2007).

Not only hedge funds offer significant benefit to the economy in general, but the risks are manageable.


II - theses destabilizing:

We saw in the previous chapter how hedge funds are primarily used to generate streams of wealth over time and contribute significantly to the efficiency of financial markets, but they can however be weapons of economic warfare.

These funds are financial operators using unusual strategies that may have destabilizing consequences for both target markets for businesses.

Hedge funds are very competitive, and always have ample access to capital, then they proceed to arbitration, so the competition among them ensures that they exploit the financial anomalies to eliminate them as they are also the origin of these anomalies playing a role in infection by the techniques of dynamic hedging and risk.

It is not easy to analyze the hazards in the case of investment in hedge funds, as seen following the strategy, the risks can be totally different. Significant risks for certain strategies are fully covered in other and vice versa.

In this chapter, we analyze the main risks caused by hedge funds. We report mainly investment risks are exposed, either directly or through funds, as we will show the role of hedge funds in the spread of the LTCM crisis and the global financial crisis and clarify the impact of strategies Selected financial stability.


A- H edge F unds: Generators risk:

The opacity that surrounds hedge funds, the near absence of regulation, and their excessive use of leverage generated great concern, and a large literature. It seeks to understand what might be the risks of their actions in terms of financial stability.

There are mainly four major areas of investigation. First, how they can be the source of systemic risk due to their interactions with major financial institutions such as commercial banks and investment, are believed to share a capacity to disrupt the financial markets on several themes by their liquidity risk, counterparty risk and ultimately their manager.


1-1 R isk systemic:

It is true that hedge funds play an important role in enhancing the efficiency and completeness of financial markets, they are important actors, often dominant, in several key market segments. They represent 40% of transaction volume of major stock exchanges. These are the main participants in the credit markets: they represent 27% of investors in bond yields as high TBMA (The Bond Market Association). More than other investors, hedge funds are pursuing global strategies, covering several markets, and can reinforce the interconnections between markets in different countries and different asset classes.

But in some cases, the activity of hedge funds can lead to one way markets and greater volatility of less liquid market segments, which means that any bad prediction will be reflected by significant financial losses, even many more important than equity funds invested, and here we talk about imbalance in financial markets./p>

Since hedge funds contribute significantly to the liquidity of certain markets, the liquidity can dry up very quickly if they decide to retire and close their positions simultaneously. Moreover, since they generally have very high leverage, they can be particularly vulnerable to a sudden drop in market liquidity.

Given their strong commitments to investment banks, hedge funds are identified as factors that drive systematic risk.

Systemic risk can be defined by the risk of widespread failure in the financial system, often conceived as a series of correlated defaults among financial institutions, typically banks, which occurs over a short period of time and usually caused by a single grand�v�nement (Potter Stewart 2008).

Part of this risk comes from the significant use of leverage enormous debt, another of the acquisition of illiquid assets (Chan et al 2005); Indeed Hedge funds have the option of using the effect of lever, what they do in fact intensively, to manage their risk and make profits in the financial markets.

The form of leverage is the simplest one used by financial intermediaries (usually investment banks active internationally), it is to grant credit lines to hedge funds so they can invest in- beyond their capital base (Geithner 2006). There yardstick more complex form used by hedge funds is that the instruments of leverage, which involves the use of a wide range of complex financial instruments. Sometimes these instruments offer significant leverage (Bank for International Settlements).

The mere fact that hedge funds have used leverage does not imply that they are risking financial stability. Indeed, if properly used, the leverage may prove to be a risk management tool very effectively. What matters really is the magnitude of its impact on VaR (value at risk) total exposure given market.

The relationship between hedge funds and financial system stability is explained by the possibility that significant losses recorded by one or more hedge funds can have a contagion effect on one or more major international banks. In extreme cases, this dynamic may be sufficient to threaten the solvency of one or several large banks and therefore undermine financial stability. This disturbance may be aggravated if the brokers conducting the margin calls have exploited the information provided by hedge funds.

The main transmission channel of systemic risk is the exposure to counterparty risk. The prime broker dealers (mostly large international banks) to provide hedge funds leverage their consent and credit lines. Because of their margin requirements and risk management of their security, they also determine the amount of instruments used by leveraging funds. The negative effects on market prices and liquidity is an important transmission channel associated with the previous.

In periods of prolonged tension in the markets, the prime broker provides services pr�tset empruntsde titles and services funding specifically suited to operations with effects of leverage of hedge funds . The dealer will probably require additional collateral or will require hedge funds to liquidate their positions to prevent further degradation of their own risk profile. Such a process can enhance market volatility and precipitate price declines.

In extreme scenarios or "extreme losses" such dynamics can cause a rapid decrease in market liquidity. According to Geithner "The interest of companies (that is to say the prime brokers) to minimize their own exposure can amplify the initial crisis and impose other operators the negative externality of a broader disturbance of market liquidity. " Besides the report of CRMPG II also states that the boundaries between credit risk and market risk tends to become blurred when the diminution in the creditworthiness and the collapse in self feed, stressing that "the liquidation of positions if it is perfectly reasonable at the micro level, reinforces the macroeconomic pressures on stock prices, which in turn cause the drying up of market liquidity of one or more asset classes "(Hildebrand 2007, p7)

Among the reasons why hedge fund risk generators is that some hedge funds are short. Their mortality rate is about historical 10% per year (Chan et al 2007). This time horizon close can encourage them to take more risk, since their strategies are focused on short-term gains.

So if we want to summarize the sources of concern regarding systemic risk, one site three mechanisms stimulators of risk:

-An increase in counterparty risk, the failure of an entity that could compromise the viability of its counterparties, thereby triggering a chain reaction.

-A reduction of market liquidity resulting from the fact that to guard against failure, a financial institution may start selling its assets and liquidate its positions, such action is likely to create sharp price corrections, if d other institutions account for their assets at market value, they will offer to turn liquidations, thus aggravating the consequences of the initial shock.

Pured�clench�e-contagion, for example, a general reassessment of risk in a specific asset class or a broad range of assets.


1-2 R isk liquidity:

In addition to systemic risk, supervisors are concerned about the indirect risks associated with the drying up of liquidity in a market segment resulting from the bankruptcy or a reduction in the activity of one or more large hedge funds .

In many markets, hedge funds are major liquidity providers and generally help spread the risk, but one concern is that, in illiquid markets, hedge funds may be forced to sell positions to meet margin call, which puts downward pressure on prices.

In extreme cases, the hedge fund may drive down the value of existing positions by an amount greater than the product of the initial sale, resulting in additional sales.

These black holes have several causes liquidity and have garnered widespread attention from academics (Persaud 2003).

When counterparties have concentrated positions, the losses of these positions are very important. Moreover, the size and dominance of hedge funds in some markets raise the risk of disorderly exits. And that is why supervisors focus on banks' ability to identify and reduce risks associated with a sharp decline in market liquidity. Banks and other market must expand their knowledge of their sensitivity to shocks, as they must always be prepared for the different scenarios that can occur, especially in scenarios that may generate losses both to their counterparts and for their own positions.

Banks must be able to consolidate and implement crisis simulation exercises by key risk factors in their overall portfolio and direct exposure at the counterparty risk. They must also learn about the controls and practices that other companies leveraged to manage liquidity risk and market liquidity risk funding.

A hedge fund portfolio is characterized by its diversification which allows to generate attractive returns with less risk than that induced by a regular portfolio.


1-3 R isk counterpart:

It is also called the counterparty credit risk is the most important risk for financial institutions as part of their relationship with hedge funds. Many hedge funds invest in illiquid securities in structured products or derivatives complex so that their calculation of risk is complex because of its bilateral nature, in other words, the net exposure between two institutions may change according to fluctuations.

In the case of some instruments, a party may become a net debtor. A simple but essential measure of counterparty risk exposure is present, namely the net exposure to current market values. This figure provides the amount that the bank would lose if a hedge fund would be bankrupt today. A more comprehensive measure is the potential future exposure, which corresponds to the maximum degree of exposure over a future with a level of statistical confidence, if the hedge fund suffers from market developments. In addition, banks stressing the potential exposures to estimate their potential increase in adverse market conditions.


1-4 risk manager and Industry:

For better risk management and portfolio, it is important that fund managers are people of integrity. It is essential that they are willing to admit mistakes and to explain to investors so that they can decide to remain in the fund or out, if the investment strategy implementation should do their more. Finally, we must ensure that the ultimate goal of managers is to make their investment decisions in the interest of existing investors. This includes the fact that they limit the amount of assets under management to a level defined at the outset, or they do not manage different funds that could compete and in which their staff vice versa is not identical.

This risk is particularly important in the case of hedge funds because the money is typically blocked for several months or years. In addition, many funds are domiciled in tax havens that protect small investors.

IT is very dangerous to invest in a fund domiciled in a tax haven only based on hearsay or on the basis of a prospectus. It is important to know the senior partner to ensure its integrity.

The risk of industry is the fact that today an increasing number of potential investments considered an investment in hedge funds. This request and the commission system performance driving up the number of funds sold. This means that a larger number of managers with assets greater, are present on alternative markets. It is therefore unlikely that the average hedge fund managers are able to provide returns as impressive as those achieved in the past because many inefficiencies tend to disappear. The best example of this phenomenon is the convertible bond market. Hedge funds now account for nearly 70% of this market.


2 - H edge F unds: D �stabilisateurs financial markets:

Hedge funds have a strong participation in the financial markets so refreshing when hedge funds will contribute positively to the efficiency and liquidity of financial markets and otherwise is to say, in the case of their bankruptcy, this will cause a recession in financial markets and financial destabilization.


2-1 C rise of LTCM:

LTCM is an abbreviation for Long Term Capital Management, which is a type of hedge funds that appeared in 1994 and founded by John Meriwether . This fund was essentially based on the massive use of leverage and application of mathematical formulas to calculate the fund managers 1a probability of success of their predictions, LTCM says his mathematical tools to rendentquatre times less risky than its competitors.

The LTCM became a machine in a few months out of control speculative.

Investors encouraged by the gain easy and important LTCM, they took positions disproportionate (In 1998 LTCM's positions represent over $ 100 billion of nominal bond markets alone). But with the crisis in emerging markets which led to the Russian default in 1998, investors fled to the safest securities, that is to say U.S. borrowing, and abandon riskier securities, whose prices fall . This comes at a time when LTCM sold short its American loans (which are increasing) and purchased thanks to the contribution of risky securities whose price collapsed. The fund is then required to pay every dollar lost in this race against the current.

Steep losses ahead. A violent reversal of trends affecting the market and hedge funds may also incur losses absolutely huge, vastly superior to their own funds (Cartapanis 2008).

So we can say that the LTCM crisis was the result of poor risk assessment of these funds and multiple operations and similar leverage especially in short selling and margin deposits. This risk was transmitted to markets; This danger of misjudgment of risks can cause losses and subsequently spread disruption of financial markets (Fung and Hsiech 2000).

This crisis was marked by dangerously high speculation that a systemic crisis triggered by the fact of trying to cover the risk of spreading the absence of hedge funds to the monetary and financial system, causing a liquidity crisis or credit, from traditional financial institutions, namely banks and endangering the functioning of financial markets. This spread is compounded by the systemic risk posed by these funds (LTCM) which propagates through the transmission channels (Cartapanis 2008).

As a result, many central banks have set up special entities for financial stability, reports on this subject have multiplied, and the Financial Stability Forum has been a renewed interest.

These funds could generate substantial profits if the circumstances were different, these funds have not been able to adjust their positions and tried to get out of the crisis without disrupting the market, yet we can not do without risk Systemic generated by these funds (Ferguson and Laster 2007).


2-2 C rise international financial:

The financial crisis that erupted in the summer of 2007 is clearly a systemic crisis. Beyond the sharp slowdown in global growth it has probably already caused, this crisis has led to systemic contagion to a range of markets, but also asset write-offs for significant amounts in the balance sheets of major financial intermediaries: the reported numbers have been increasing for several months and $ 1,000 billion of losses will almost certainly be exceeded (IMF 2008).

When the subprime crisis broke out, the form, initially, the illiquidity of most subprime derivatives markets, the eyes naturally turned to hedge funds (and Cartapanis Te�letche, 2008) simply because they are major players in credit derivatives. A. Blundell-Wignall recently provided one of the few estimates of the distribution of buyers of different tranches of CDOs (collateralized debt obligations) at the time of crisis, hedge funds held more than 46% of the total, but especially over 80 % of the riskiest tranches (equity). With nearly 1,400 billion holding CDO tranches, compared with 2,000 billion in assets under management, hedge funds have thus found in the heart of the subprime crisis.

Ultimately, however, with a big ten funds in trouble and less than twenty billion dollars in losses in 2007, it is well below the planned figure for banks. Hedge funds appear to have been much less penalized by the crisis in U.S. mortgage derivatives. In a recent estimate by the IMF in 2008 also considers that hedge funds suffered only 22.8% of subprime-related losses in 2006, against 53.3% for banks.

According Cartapanis, in 2008, the 2007-2008 financial crisis is the result of a chain of causality, the unreasonable extension of subprime mortgages to securitization indiscriminate in their slices of increasingly risky credit derivatives, including effects of higher U.S. interest rates. The massive acquisition of CDOs or ABCP (Asset Backed Commercial Paper) from hedge funds, in an atmosphere of euphoria, of course, has fueled the systemic risk. So even if hedge funds are not the cause of the outbreak of the financial crisis of 2007-2008, they found themselves in the heart of systemic interdependencies that led to the chain of asset devaluations and the crisis of illiquid because of their commitments with prime brokers and associated leverage.

The securitization of mortgages could not contribute to the efficient dispersion of initial risks, and this is only the result of unreasonable notations and especially the leverage that everything had changed both the scale and nature of the subprime risk . The first level of risk, given the magnitude of accumulated short positions by hedge funds, and banks or insurance companies, on the whole subprime derivatives , far beyond the specific risk of non-recovery of a share of U.S. mortgages. The nature of the risk then, given the relationship between the level of leverage, the overall dynamics of the economic system and the credit cycle. Because the effects are pro-cyclical leverage (White, 2008).

It is in the euphoric atmosphere of the first half of the 2000s that, at the same time, subprime loans have developed strongly in the U.S., credit derivatives have increased the leverage provided by prime brokers, and So by banks, have increased significantly, not to mention the inflation of asset prices (Morgan 2008).


2-3 Impact of leverage on financial markets :

The leverage is used by hedge fund managers when they think the cost of borrowing funds will be minimal compared to the returns on their investments. This can be a key point of running a hedge fund because it gives managers the opportunity to significantly improve performance (but also more potential loss). Leverage adopt different investment strategies:

- Strategies "actions" pose a greater risk profile and thus the lever is typically 1.5 to 2. However, although the strategies 'actions' are more volatile, a balance of profitable positions and losers in the portfolio significantly limit the impact of a sharp rise or decline in the market.

- Strategies bond risk levels lower (but lower expected returns) in such a way that is common to have a lever 4 or 5 times the value of funds. Indeed, in a crisis major financial, the complex range of exposures to hedge funds and highly leveraged dealer institutions may increase the risk of spreading problems of a financial institution to other institutions. Leverage creates a change in the size of positions taken by hedge funds, which could grant them a special role in the dynamics of crises. Nearly 10,000 funds currently manage between 1,400 and 2,000 billion dollars assets, an annual growth of around 20% since the early 2000s (Ferguson and Laster 2007). Hedge funds allocate their borrowing from banks (prime brokers) and deposit the loan on their behalf, If hedge funds can not repay the loan, the financial institution creditor can then sell it to repay the loan. The ability to have in the investment portfolio of short positions (short) that is- say short sell securities that do not have hedge funds hoping to buy them later by a lower price to repay them, thereby increasing the potential for additional performance: the expected return on the portfolio hedge funds larger than the mutual funds for the same risk level (8.1% against 6.5). Debt is one of the main techniques adopted by hedge funds to boost performance. However, as it is costly borrow money directly by contacting a bank, hedge fund managers generally exert leverage on their investment capital by buying securities on margin, that is to say on credit. For this, it deposits a security deposit, in cash or securities, in its prime broker. Hedge funds are liquidity providers by the leverage in bull markets and they propagate systemic risk by If the markets go down.


2-4 Effects of strategies:

A hedge fund portfolio is characterized by its diversification which allows to generate attractive returns with less risk than that induced by a regular portfolio and can also adopt various positions and strategies enabling them to obtain higher yields. but also the opportunity to choose strategies counterparts because they are characterized by transparency and information they rely has implemented a low cost, but also contributes a greater risk than the other, in effect, an adjustment homologous positions can induce market illiquidity and lower prices then the risk that hedge funds will support it is counterparty risk. If a fund has to fail, it can affect all financial institutions. Better speculation of liquidity can be a way to limit systemic risk. Hedge funds improve the market too small and therefore subject to price anomalies. Price volatility can be reduced by the use of arbitrage operations to correct pricing anomalies, their strategies include arbitrage. Simply put, they purchase financial securities whose price is relatively low, and sell financial securities whose price equivalent is relatively high. In doing so, they unify and stabilize the markets, and correct anomalies they identify. Able to take large positions, they provide the required liquidity to markets to stabilize. Competition prevailing between hedge funds ensures they do not usually generate sustained profitability abnormally high. (Chaigneau 2007). In addition, hedge funds flexibly manage the overall exposure of portfolios, especially in times of extreme risk aversion, hedge funds offer more diversification opportunities to investors which involve a more comprehensive and market promotion financial innovations in order to react flexibly and quickly to changing market conditions wholes these elements can contribute to financial stability. The negative effects of hedge funds sue financial stability, there are mainly two major areas of investigation. First, how they can be the source of systemic risk due to their interactions with major financial institutions such as the heavy reliance on borrowing: Indeed, their opportunistic strategies with high leverage are potentially a threat for financial stability, given the multiple relationships they have with banks. The lack of regulations regarding borrowing money they can use an unlimited short selling. The problem is therefore the central levers when addresses the issue of hedge funds because, although they still represent a small share of the amount of transactions on financial markets, debt, sometimes excessive, may pose a risk of bankruptcy to cause financial crises. In Secondly, it is suspected from them an ability to disrupt financial markets, such as excess volatility or distortion of asset prices. If an investor in a market of small to medium sized wrongly anticipated price movements of hedge funds and is heavily indebted that it pushes to liquidate its assets to more liquid by selling them at very low prices which induces a high volatility in financial markets. These sudden disturbances can then create excess volatility momentary nature to increase uncertainty and lead to liquidity crises. Levers and therefore the main consequence of weakening the funds that become much more sensitive to market disturbances. A simple perturbation can be amplified by hedge funds to become a real shock in financial markets. (Franck Martin)


General conclusion

This research has attempted to provide answers to questions related to new

Hedge funds. Let's start by quoting this:

"If you think education is expensive, try ignorance" (Derek Bok, former president of Harvard)

We could adapt this sentence as follows:

"If you think hedge funds are risky, try stocks."

Thus, our research has shown that hedge funds represent a complex, heterogeneous, sometimes fuzzy, but those trying to understand this world can take advantage of exciting opportunities. The introduction of hedge funds in a portfolio standard, properly conducted, can optimize the risk / reward ratio.

Hedge funds are, first, the result of a significant improvement in asset management techniques. These improvements are likely to last, regardless of the changing regulatory environment to the extent that these techniques will increasingly be part of the traditional management of assets.

Hedge funds are growing rapidly: they increased from $ 39 billion in assets under management in 1990 to 1,400 billion at the fi n the third quarter 2006and through this rapid growth and to use the leverage that activity of hedge funds have a significant impact on financial markets.

Hedge funds provide benefits to investors and improve the allocation of risk and stability of financial markets, it is often that hedge funds provide liquidity and stability to financial markets, and support asset prices sharply devalued and overall hedge funds tend to mitigate systemic risk.

Thus, the impact of return on equity on the market has been highlighted, confirming the hypothesis of sophisticated arbitrageurs able to give impetus to the market.

Hedge funds have strong future prospects, with a growing influence and impact on financial systems markets. They have helped increase market liquidity and ensure efficiency, but it should treat the systemic risks they pose in terms of financial market stability.

If it appears that hedge funds liquefy the markets, it is true that some of them are run can be systemic risk in the international financial system.

Hedge funds are a tool that allows those who can effectively manage their risk of de correlate their classic portfolio while improving performance e of it.

Source: Essay UK - http://turkiyegoz.com/free-essays/finance/hedge-funds.php


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