Although risk management has been a well-plowed field in financial modeling for over two decades, traditional risk management tools such as mean-variance analysis, beta, and Value-at-Risk do not capture many of the risk exposures of hedge-fund investments. In this article, I review several aspects of risk management that are unique to hedge funds - survivorship bias, dynamic risk analytics, liquidity, and nonlinearities - and provide examples that illustrate their potential importance to hedge-fund managers and investors. I propose a research agenda for developing a new set of risk analytics specifically designed for hedge-fund investments, with the ultimate goal of creating risk transparency while, at the same time, protecting the proprietary nature of hedge-fund investment strategies.

A new methodology for statistically testing contingent-claims asset-pricing models based on asymptotic statistical theory is proposed. It is introduced in the context of the Black-Scholes option-pricing model, for which some illustrative estimation, inference, and simulation results are also presented. The proposed methodology is then extended to arbitrary contingent claims by first considering the estimation problem for general Itô processes and then deriving the asymptotic distribution of a general contingent claim which depends upon such Itô processes.

Duchenne muscular dystrophy (DMD) is a rare genetic disorder affecting thousands of individuals, mainly young males, worldwide. Currently, the disease has no cure, and is fatal in all cases. Advances in our understanding of the disease and innovations in basic science have recently allowed biotechnology companies to pursue promising treatment candidates for the disease, but so far, only one drug with limited application has achieved FDA approval. In this case study, we profile the work of an early-stage life sciences company, Solid Biosciences, founded by a father of a young boy with DMD. In particular, we discuss Solid’s one-disease focus and its strategy to treat the disease with a diversified portfolio of approaches. The company is currently building a product pipeline consisting of genetic interventions, small molecules and biologics, and assistive devices, each aimed at addressing a different aspect of DMD. We highlight the potential for Solid’s business model and portfolio to achieve breakthrough treatments for the DMD patient community.

We examine the relation between changes in hedge fund equity holdings and measures of informational efficiency of stock prices derived from intraday transactions as well as daily data. On average, hedge fund ownership of stocks leads to greater improvements in price efficiency than mutual fund or bank ownership, especially for stocks held by hedge funds with high portfolio turnover and superior security selection skills. However, stocks held by hedge funds experienced large declines in price efficiency in the last quarter of 2008, particularly if the funds were connected to Lehman Brothers as a prime broker and used leverage in combination with lenient redemption terms.

We apply spectral techniques to analyze the volatility and correlation of U.S. common-stock returns across multiple time horizons at the aggregate-market and individual-firm level. Using the cross-periodogram to construct frequency bandlimited measures of variance, correlation and beta, we find that volatilities and correlations change not only in magnitude over time, but also in frequency. Factors that may be responsible for these trends are proposed and their implications for portfolio construction are explored.

The authors introduce a new approach to identifying and monitoring systemic risk that combines network analysis and tail risk contribution (TRC). Network analysis provides great flexibility in representing and exploring linkages between institutions, but it can be overly general in describing the risk exposures of one entity to another. TRC provides a more focused view of key systemic risks and richer financial intuition, but it may miss important linkages between financial institutions. Integrating these two methods can provide information on key relationships between institutions that may become relevant during periods of systemic stress. The authors demonstrate this approach using the exposures of money market funds to major financial institutions during July 2011. The results for their example suggest that TRC networks can highlight both institutions and funds that may become distressed during a financial crisis.

With the rise of social media, investors have a new tool for measuring sentiment in real time. However, the nature of these data sources raises serious questions about its quality. Because anyone on social media can participate in a conversation about markets—whether the individual is informed or not—these data may have very little information about future asset prices. In this article, the authors show that this is not the case. They analyze a recurring event that has a high impact on asset prices—Federal Open Market Committee (FOMC) meetings—and exploit a new dataset of tweets referencing the Federal Reserve. The authors show that the content of tweets can be used to predict future returns, even after controlling for common asset pricing factors. To gauge the economic magnitude of these predictions, the authors construct a simple hypothetical trading strategy based on this data. They find that a tweet-based asset allocation strategy outperforms several benchmarks—including a strategy that buys and holds a market index, as well as a comparable dynamic asset allocation strategy that does not use Twitter information.

Moderator Martin Leibowitz asked a panel of industry experts—Andrew W. Lo, Robert C. Merton, Stephen A. Ross, and Jeremy Siegel—what they saw as the most important issues in finance, especially as those issues relate to practitioners. Drawing on their vast knowledge, these panelists addressed topics such as regulation, technology, and financing society’s challenges; opacity and trust; the social value of finance; and future expected returns.

A crisis is building over the prices of new transformative therapies for cancer, hepatitis C virus infection, and rare diseases. The clinical imperative is to offer these therapies as broadly and rapidly as possible. We propose a practical way to increase drug affordability through health care loans (HCLs)—the equivalent of mortgages for large health care expenses. HCLs allow patients in both multipayer and single-payer markets to access a broader set of therapeutics, including expensive short-duration treatments that are curative. HCLs also link payment to clinical benefit and should help lower per-patient cost while incentivizing the development of transformative therapies rather than those that offer small incremental advances. Moreover, we propose the use of securitization—a well-known financial engineering method—to finance a large diversified pool of HCLs through both debt and equity. Numerical simulations suggest that securitization is viable for a wide range of economic environments and cost parameters, allowing a much broader patient population to access transformative therapies while also aligning the interests of patients, payers, and the pharmaceutical industry.

We extend the megafund concept for funding drug discovery to enable dynamic leverage in which the portfolio of candidate therapeutic assets is predominantly financed initially by equity, and debt is introduced gradually as assets mature and begin generating cash flows. Leverage is adjusted so as to maintain an approximately constant level of default risk throughout the life of the fund. Numerical simulations show that applying dynamic leverage to a small portfolio of orphan drug candidates can boost the return on equity almost twofold compared with securitization with a static capital structure. Dynamic leverage can also add significant value to comparable all-equity-financed portfolios, enhancing the return on equity without jeopardizing debt performance or increasing risk to equity investors.