Hedge Funds, Operational Risk, and the Implementation of Basel 2 Essay by Top Papers

Operational risk can be defined as "risk without reward" because it is the only risk faced by investors that does not result in increased returns (The Bank et al., 2006). In the past, Basel 1 only weighed accounts for credit and market risk, however, Basel 2 aims to make capital requirements more risk sensitive and takes into account these operational risks as well (Espenilla, San Pedro, & Prenio, 2005). Much of this operational loss can take place in hedge funds, which have recently been the focus of fraud cases and the increasing inflow of institutional capital into these funds. In addition, the type and quality of hedge fund can vary widely within the marketplace, therefore, the diligent investor must determine whether the hedge fund manager is legitimate. This can be difficult when equity managers may have an enormous amount of assets, but have very few employees, appearing as though the organization may not be reliable.