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Moral Hazards in Hedge Fund Management March 16, 2008

Posted by federalist in Finance.
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Via MarginalRevolution, Foster & Young give a poignant example of the perils of hedge funds: Essentially, derivatives allow funds to take highly skewed bets, and the industry’s opacity and complexity can conceal these tail risks (unless they actually hit). Foster & Young point out that a malicious manager could easily exploit this situation to make a fortune with a high probability. I touched on some countermeasures that investors should use to control for this, although even the smartest and best-intentioned investors can be ambushed and ruined by unforeseen “tail events.”

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