Leveraged Investor Disclosures and Concentrations of Risk
41 Pages Posted: 8 Mar 2007
Date Written: October 27, 2003
We analyze a model where investors (e.g. hedge funds) need to borrow from lenders with heterogeneous risk-exposures. Investors may obtain advantageous terms of borrowing by disclosing their investment strategy, thereby revealing its correlation to the lender's existing risk-exposure. Investors risk being "front-run" by their lender if they disclose, however. We show that in the presence of front-running, the "unraveling" result of full disclosure may not hold. Mandating disclosure has ambiguous welfare effects since it can not only lead to the matching of uncorrelated risks, but also to concentrations of risk. These results have implications for regulations on leveraged investors in financial markets.
Keywords: hedge funds, leverage, counterparty, front-running, disclosure, financial intermediaries, credit risk, risk concentrations
JEL Classification: G2, N2
Suggested Citation: Suggested Citation