How to Lose Money in Derivatives: Examples from Hedge Funds and Bank Trading Departments

58 Pages Posted: 7 May 2014

See all articles by Sebastien Lleo

Sebastien Lleo

NEOMA Business School

William T. Ziemba

University of British Columbia (UBC) - Sauder School of Business; Systemic Risk Centre - LSE

Date Written: April 19, 2014

Abstract

What makes futures hedge funds fail? The common ingredient is over betting and not being diversified in some bad scenarios that can lead to disaster. Once troubles arise, it is difficult to take the necessary actions that eliminate the problem. Moreover, many hedge fund operators tend not to make decisions to minimize losses but rather tend to bet more doubling up hoping to exit the problem with a profit. Incentives, including large fees on gains and minimal penalties for losses, push managers into such risky and reckless behavior. We discuss some specific ways losses occur. To illustrate, we discuss the specific cases of Long Term Capital Management, Niederhoffer’s hedge fund, Amaranth and Société Genéralé. In some cases, the failures lead to contagion in other hedge funds and financial institutions. We also list other hedge fund and bank trading failures with brief comments on them.

Keywords: hedge fund trading disasters, over betting, Long Term Capital Management, Amarath and Société Genéralé

JEL Classification: G01, G21, G23, G33

Suggested Citation

Lleo, Sebastien and Ziemba, William T., How to Lose Money in Derivatives: Examples from Hedge Funds and Bank Trading Departments (April 19, 2014). Available at SSRN: https://ssrn.com/abstract=2433506 or http://dx.doi.org/10.2139/ssrn.2433506

Sebastien Lleo (Contact Author)

NEOMA Business School ( email )

Reims
France

William T. Ziemba

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-261-1343 (Phone)
604-263-9572 (Fax)

HOME PAGE: http://williamtziemba.com

Systemic Risk Centre - LSE ( email )

Houghton St, London WC2A 2AE, United Kingdom

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