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On September 18, LTCM officials contacted Federal Reserve Bank of New York President William Mc Donough about its financial problems.A team from the New York Fed visited LTCM two days later.In this environment, .” “When fund managers consider the possibility of runs, they optimally hold less market exposure.” “When…runs are possible…fund managers can also interact with each other by deciding whether to stay, because investors request capital withdrawals in proportion to the number of exiting funds.Therefore, the investment decision of each fund affects the others’ investment returns and obviously affects optimal decisions…when the market regime changes from a normal state (in which runs are impossible) to a bad state (in which runs are possible), fund managers quickly reduce risky asset exposure prior to the occurrence of runs, which could encourage these funds to run…Using a global game method, we show that a unique threshold strategy exists in which, if the liquidity shock is below the threshold, no managers run but, otherwise, all managers run.” “When fund managers hold a large amount of risky asset, their investment returns are closely related to each other, so .
The Fed came to be concerned that if LTCM’s extensive list of counterparties tried to exit their positions at the same time, it would create a rapid and widespread sale of assets, a fire sale, which could potentially impair the economy.Hedge funds’ capital structure is vulnerable to market shocks because most of them offer high liquidity to loss-sensitive investors.Moreover, hedge fund managers form expectations about each other based on market prices and investor flows.by hedge funds during the global financial crisis.” “The probability of market runs…is related to the distribution of funding liquidity shocks…the likelihood of runs rises as both the market exposure of funds and the price sensitivity of trend followers increase….” “Panic-based crises [are] crises that occur just because agents believe they are going to occur, which is the common feature of most crises in several parts of the financial sector…Hedge fund managers, sharing common investors and interacting with each other through market price, sensitively react to other funds’ investment decisions.
Using its high leverage, LTCM sought profits in a broad range of markets – including those for government bonds, mortgage-backed securities, and equities – and entered into derivatives contracts extensively, including those for swaps, forwards, and options (Department of the Treasury, et al. In 1998, the financial markets crisis that had started in Southeast Asia the previous year intensified.