The Amaranth Debacle: Failure of Risk Measures or Failure of Risk Management?

Abstract:     
The speculative activities of hedge funds are a hot topic among market agents and authorities. In September 2006, the activities of Amaranth Advisors, a mid-sized Connecticut hedge fund sent menacing ripples through the natural gas market. By September 22, 2006, Amaranth had lost roughly $5.85B or two thirds of its assets due to its activities in natural gas futures and options. Three months later, Amaranth funds were being liquidated. This paper presents a detailed investigation of the possible causes behind this spectacular hedge fund failure and draws lessons by assessing Amaranth's trading activities within a standard risk management framework. Even by very conservative measures, Amaranth was engaging in highly risky trades which (in addition to high levels of market risk) involved significant exposure to liquidity risk - a risk factor that is notoriously difficult to manage.

Number of Pages in PDF File: 49

Keywords: Amaranth, hedge funds, natural gas futures, options, risk measurement

JEL Classification: G0

working papers series