Explanation:
Long-Term Capital Management (LTCM) appeared to be highly diversified across multiple geographic markets and asset classes. However, almost all of their convergence arbitrage trades shared a common underlying risk factor: the assumption that credit spreads, risk premiums, and market volatility would revert to their historical means and decline. When the 1998 Russian financial crisis occurred, there was a global "flight to quality," causing spreads and volatility to widen everywhere simultaneously, which led to devastating correlated losses across LTCM's supposedly diversified portfolio.
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Q.99 Although LTCM was well diversified across the globe across different assets and trading assets, it still proved difficult to shake off-market risk. Which of the following best explains why the market risk remained persistent?
A
All of its trading strategies were hinged on a single economic prediction: that risk premiums and market volatility would decline.
B
The diversification was somewhat narrow-based i.e., the fund concentrated on just a few similar assets.
C
Imitators flooded the market creating a situation where LTCM served as the market maker, rather than the price taker.
D
None of the above.
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