Getmansky, Mila, "Limits of Arbitrage: Understanding How Hedge Funds Fail", 2005 July 17-2005 July 21
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Even if arbitrage opportunities are found in a statistical sense, they might not be exploitable due to unexpected widening of spreads. This paper models such a case in the framework of a hedge fund. Specifically, Long Term Capital Management is presented as a case study. In particular, we calculate the likelihood of hedge fund failure and survival given different statistical arbitrage opportunities and hedge fund risk management decisions. Dynamic relationships between a hedge fund, dealer, and market (investor) are modeled.