Rethinking risk control

Wed Nov 1, 2006



Investors and managers ignore the obvious, and the extreme, at their peril

Two years ago, when a $2 billion hedge fund hired its first-ever risk management chief, the firm's portfolio manager was pretty explicit in framing the job description. "If I ever overrule you," he wrote in the new hire's contract, "and you do not call me on it and stop me, you're fired." At the vast majority of hedge funds, one can hardly hope to find so explicit a commitment to independent risk control. If one had been in place at Amaranth Advisors, might the firm have curtailed its trading instead of increasing its stake in the risky natural gas positions that led to its destruction?

The temptation has been great, following the collapse at Amaranth, to question if risk management systems that aim to predict typical and abnormal losses failed to detect the risks inherent in the trade that...

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