Risk Management Lessons from Madoff Fraud

39 Pages Posted: 18 Mar 2009 Last revised: 8 Apr 2009

Pierre Clauss

Société Générale; Université d'Évry - Centre D'Etudes des Politiques Economiques et de L'Emploi (EPEE)

Thierry Roncalli

Amundi Asset Management; University of Evry

Guillaume Weisang

Clark University - Graduate School of Management

Date Written: March 12, 2009

Abstract

In December 2008, as the financial and economic crisis continued on its devastating course, a new scandal bursts. After the 1998's failure of Long-Term Capital Management, Madoff's fraud brings once again the discredit on the hedge funds industry. This one is however of a different kind. Indeed, Madoff's firm is not a standard hedge fund but a developed Ponzi scheme. By explaining Madoff's system and exploring the reasons to its collapse, this paper draws risk management lessons from this fraud, especially for operational risk management. Risk management rules as applied nowadays partially failed to prevent Madoff's scandal. This paper presents the issues for risk capital requirements raised by Madoff collapse. Implications for due diligence processes, including the use of quantitative replication to assess hedge fund performance's credibility, are also considered. Finally, consideration is given to the regulatory and standardizing approaches of the hedge fund industry as an answer to frauds of Madoff's kind.

Keywords: Madoff fraud, Ponzi scheme, operational risk, due diligence, supervision, hedge funds, bull spread strategy, split strike conversion

JEL Classification: G1, G3

Suggested Citation

Clauss, Pierre and Roncalli, Thierry and Weisang, Guillaume, Risk Management Lessons from Madoff Fraud (March 12, 2009). Available at SSRN: https://ssrn.com/abstract=1358086 or http://dx.doi.org/10.2139/ssrn.1358086

Pierre Clauss

Société Générale ( email )

Université d'Évry - Centre D'Etudes des Politiques Economiques et de L'Emploi (EPEE) ( email )

Boulevard Francois Mitterrand
F-91025 Evry Cedex
France

Thierry Roncalli

Amundi Asset Management ( email )

90 Boulevard Pasteur
Paris, 75015
France

University of Evry ( email )

Boulevard Francois Mitterrand
F-91025 Evry Cedex
France

Guillaume Weisang (Contact Author)

Clark University - Graduate School of Management ( email )

950 Main Street
Worcester, MA 01610
United States

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