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FINANCE /
HEDGE FUNDS / RISK MANAGEMENT |
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Problem |
Hedge funds invest in privately traded securities whose
true value is obscured by many conflicting indicative prices estimated by a
small collection of broker dealers. |
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Partners and Sponsors |
Capital
Market Risk Advisors (CMRA) and AdKap L.L.C. |
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Challenge |
Come up with a system that allows a full extension of
standard financial tools to analyze these ‘translucent’ securities, while at the
same time incorporating the lack of a reliable price. |
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Customized Toolkit |
For this problem we chose an approach using the risk
calculus of von Neumann - Morgenstern together with choices of functional
forms from probability theory (modified Gamma and Beta Distributions) and
Arrow-Pratt risk aversion. |
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Solution |
Treat the blizzard of indicative prices as a source of
additional risk so that risk averse investors should expect additional
compensation as the prices spread out. Then use the indicative prices as if
they were a random sample from a probability distribution governing the true
price. Use the risk aversion of the investor to discern a certainty
equivalent in the form of a definite spot price of a hypothetical liquid
security. Because the spot price exists while the equivalent liquid security
does not exist, we called certainty equivalent the phantom price. |
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Contact |
If
your interests are related to this topic, please contact us at finance@eric-weinstein.net or by
visiting us at our website: www.transparentrisk.com. |
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