Hedge Funds and Financial Stability: Regulating Prime Brokers Will Mitigate Systemic Risks

15 Pages Posted: 9 Nov 2008 Last revised: 18 Jun 2009

See all articles by Michael R. King

Michael R. King

Gustavson School Of Business

Philipp Maier

Bank of Canada - International Department

Date Written: March 10, 2009

Abstract

We review key characteristics of the hedge fund industry, and identify conditions under which this sector can pose a threat to financial stability. Direct regulation of hedge funds that increases transparency does not appear feasible, may create a moral-hazard problem, and may reduce market liquidity. Indirect regulation by prime brokers and market discipline by creditors, counterparties, and investors have been effective in limiting the risks from the hedge fund sector. To reduce systemic risks, more regulation of prime brokers is warranted to avoid competitive dynamics from undermining counterparty risk management practices.

Keywords: Hedge funds, Regulation, Systemic crisis, Counterparty risk, LCFIs

JEL Classification: G2, G18

Suggested Citation

King, Michael Robert and Maier, Philipp, Hedge Funds and Financial Stability: Regulating Prime Brokers Will Mitigate Systemic Risks (March 10, 2009). Journal of Financial Stability, Vol. 5, 2009, Available at SSRN: https://ssrn.com/abstract=1297188 or http://dx.doi.org/10.2139/ssrn.1297188

Michael Robert King (Contact Author)

Gustavson School Of Business ( email )

University of Victoria
Business & Economics Building, Room 246
Victoria, British Columbia V8W 2Y2
Canada
250-721-6425 (Phone)

HOME PAGE: http://https://www.uvic.ca/gustavson/faculty/faculty/faculty/current/kingm.php

Philipp Maier

Bank of Canada - International Department ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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