#07-17
Hedge Funds, Financial Intermediation and Systemic Risk
John Kambhu, Til Schuermann and Kevin J. Stiroh, June 2007
Abstract: Hedge funds are significant players in the U.S. capital markets, but differ from other market
participants in important ways such their use of a wide range of complex trading strategies and
instruments, leverage, opacity to outsiders, and their compensation structure. The traditional bulwark
against financial market disruptions with potential systemic consequences has been the set of
counterparty credit risk management (CCRM) practices by the core of regulated institutions. The
characteristics of hedge funds make CCRM more difficult as they exacerbate market failures linked to
agency problems, externalities, and moral hazard. Nonetheless, we conclude that CCRM remains the
best line of defense against systemic risk and that direct regulation of hedge funds is not desirable.
Keywords: banks; counterparty credit risk management; liquidity.
JEL classifications: G12, G21.
