The downfall of the Long-Term Capital Management (LTCM) hedge fund in 1998 can be attributed to not just one, but two financial “weapons of mass destruction”:
- Overleverage: LTCM relied heavily on leverage, meaning it borrowed significant amounts of money to fuel its trades. This left it exposed to substantial losses if the market went against its positions.
- Derivatives: LTCM extensively employed derivatives, intricate financial instruments with inherent risk. As the market turned against LTCM, it was compelled to offload its derivatives at a loss.
It’s important to note that these factors are unrelated to AI. While similar scenarios might unfold in AI-based algorithmic trading, it’s crucial to understand that algorithmic trading inherently involves a Man+Machine approach. Human oversight governs the algorithms, and the machine carries out the executions.
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