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The impact of the activities of investors and speculators on financial markets has long been of great interest to academics and practitioners alike.1 Since 2000, the amount of assets managed by hedge funds has nearly tripled from a total of $490 billion to $1,336 billion and although still a small percentage of total assets worldwide, hedge funds account for an even larger part of the liquidity in certain markets (HFR Industry Report [2006]). In September 2006, the activities of a Connecticut hedge fond named Amaranth Advisors LLC2 significantly impacted the natural gas market. Building up large losses in trading natural gas futures, the story of Amaranth bears all the hallmarks of a near miss in terms of endangering systemic financial stability. What happened? What went wrong? And most importantly-perhaps-does this strengthen the widespread call for tighter regulation of hedge fonds or the futures market?3 This article addresses these questions in more detail. Furthermore, the article looks for answers on whether the failure of Amaranth was just "business as usual" in the natural rise and fall of hedge funds or if standard risk management practice could have signalled that something was amiss.
At least since the spectacular implosion of LTCM, hedge funds have been featured prominently in regulators' primary concerns about maintaining the orderly functioning of markets. Indeed, in recent years, regulators have actively debated the merits of a more prudent regulatory framework for hedge funds both in public and more private settings such as the Basel Committee for Banking Supervision.4 In the collapse of Amaranth by September 21, 2006, the firm had lost roughly $4.35 billion or one half of its assets under management as a result of its energy trading business, in particular, the funds' activities in natural gas futures and options. These losses occurred in just under a month between August 31 and September 21, 2006 (assets fell from $9.67 billion to $5.32 billion). The fund consequently sold its energy portfolio trading book to J.P. Morgan and Citadel Investments and liquidated the remainder of its portfolio.
Since the collapse of Amaranth in September 2006, several authors have attempted to understand what positions and risk levels Amaranth was engaged in to cause such a dramatic collapse (Chincarini [2006, 2007] and Till [2006]). Chincarini...