Risk register · entry
Q4 · Where models dieLTCM
Two Nobel laureates, 25-to-1 leverage, and a model that met reality.
The world stops matching the model. Regime change and leverage turn a small error fatal.
Why this room
LTCM's payoff structure looked simple on paper (small, well-modeled spread trades) but the true complexity sat in the hidden correlation across thousands of positions, and the tail behavior was catastrophic and fast rather than gradual, the signature combination of high modeled-simplicity paired with fat-tailed, model-breaking outcomes that defines Q4.
The record
- Founded 1994 by John Meriwether; initial capital ~$1.01 billion by Feb 24, 1994certain
- Partners Myron Scholes and Robert Merton won the 1997 Nobel Prize in Economicscertain
- Annual returns: 21% (1995), 43% (1996), 41% (1997)certain
- Early 1998 equity ~$4.7-5 billion vs. borrowed funds ~$124.5-125 billion (~25-to-1 leverage, one source says ~30-to-1)likely
- Off-balance-sheet derivatives notional ~$1.25 trillionlikely
- Russia devalued the ruble and defaulted on 281 billion roubles (~$13.5 billion) of debt on August 17, 1998certain
- Equity fell from ~$2.3 billion (Sept 1) to ~$400-600 million (Sept 22-25, 1998)likely
- Total losses ~$4.6 billion over about four months in 1998certain
- Buffett/Goldman/AIG offered ~$250 million for the fund's positions on Sept 23, 1998, rejected within the hourlikely
- Fed-brokered bailout: 14 banks injected $3.625 billion (sometimes rounded to $3.5-3.6 billion) for 90% of the fund, Sept 23, 1998certain
- Fund dissolved in early 2000; rescuing banks recovered their investmentlikely
- Model treated the 1998 loss event as roughly a 10-standard-deviation occurrence under a Gaussian distributionuncertain
Sources
The book
This entry is one of 111 in the register. The full story, and what it cost the people who lived it, is in Risky Business by Claudia Zeisberger, David Munro and Joanna Reijgersberg-Siew.
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