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Unformatted text preview: Electronic copy available at: http://ssrn.com/abstract=1301217 Hedge Funds, Systemic Risk, and the Financial Crisis of 2007–2008 Written Testimony of Andrew W. Lo ∗ Prepared for the U.S. House of Representatives Committee on Oversight and Government Reform November 13, 2008 Hearing on Hedge Funds 1. Introduction Chairman Waxman, Ranking Minority Member Davis, and other members of the House Oversight Committee, I would like to start by thanking you for giving me an opportunity to testify at this hearing on the role of hedge funds in our financial system and their regulatory and tax status. In the interest of full disclosure, I wish to inform the committee that I am a principal investigator in a project funded by the National Science Foundation, and in addition to my academic position at MIT, I am affiliated with an asset management company that manages several hedge funds and mutual funds. Before turning to the substance of my testimony—hedge funds, systemic risk, and regulatory oversight—in this introductory section I would like to summarize the most important themes: 1. Financial crises may be an unavoidable aspect of modern capitalism, a consequence of the interactions between hardwired human behavior and the unfettered ability to innovate, compete, and evolve. But even if crises cannot be avoided, their disruptive effects can be reduced significantly by ensuring that the appropriate parties are bearing the appropriate risks, and this is best achieved through greater transparency, particularly in the so-called “shadow banking system”. Government can play a central role in providing such transparency. 2. Before we can hope to manage the risks of financial crises effectively, we must be able to define and measure those risks explicitly. Therefore, the first order of business for designing new regulations is to develop a formal definition of systemic risk and to construct specific ∗ Harris & Harris Group Professor, MIT Sloan School of Management, and Chief Scientific Officer, AlphaSimplex Group, LLC. Please direct all correspondence to: Andrew W. Lo, MIT Sloan School of Management, 50 Memorial Drive, E52–454, Cambridge, MA 02142. The views and opinions expressed in this article are those of the author only, and do not necessarily represent the views and opinions of AlphaSimplex Group, MIT, any of their affiliates and employees, or any of the individuals acknowledged below. The author makes no representations or warranty, either expressed or implied, as to the accuracy or completeness of the information contained in this article, nor is he recommending that this article serve as the basis for any investment decision—this article is for information purposes only. I am grateful to Jerry Chafkin, John Cox, Arnout Eikeboom, Jacob Goldfield, Gilles Guerin, Joe Haubrich, Bob Jarrow, Amir Khandani, Bob Merton, Maureen O’Hara, and Phil Vasan for helpful comments and discussion, and I thank AlphaSimplex and the MIT Laboratory for Financial Engineering for research support. Electronic copy available at: http://ssrn.com/abstract=1301217Electronic copy available at: http://ssrn....
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This note was uploaded on 10/16/2011 for the course FIN 353 taught by Professor Cobus during the Spring '08 term at S.F. State.
- Spring '08