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

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

Michael R. King

Ivey Business School

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 R. 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)

Ivey Business School ( email )

Western University
1255 Western Road
London, Ontario N6G 0N1
Canada
519 661 3084 (Phone)

HOME PAGE: http://www.ivey.uwo.ca/faculty/directory/michael-king/

Philipp Maier

Bank of Canada - International Department ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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