Cornerstone Research assisted with a regulatory investigation following the closure of a global macro hedge fund.
The Swiss National Bank (SNB) suddenly and unexpectedly announced in January 2015 that it would no longer hold the Swiss franc at a fixed exchange rate with the euro, after previously assuring the public it would keep the peg. In the wake of this announcement, the Swiss franc appreciated by more than 18 percent against the euro (EUR/CHF) over the course of a month and a number of hedge funds around the world incurred large losses.
In the context of an SEC investigation, defense counsel retained Cornerstone Research to analyze the losses incurred by a hedge fund with a large exposure to the EUR/CHF. Cornerstone Research analyzed the fund’s detailed portfolio holdings, including the EUR/CHF position that led to losses, as well as the fund’s overall strategy and risk management.
Cornerstone Research concluded that the probability of the Swiss franc appreciating by more than 18 percent over the course of a month was negligible, based on an analysis of the implied volatility of foreign exchange options.
In particular, Cornerstone Research was asked to analyze the ex-ante (before the SNB’s announcement) likelihood of a large movement in the exchange rate. To derive a distribution of future exchange rate changes, we implemented a forward-looking, market-based approach that used the prices on a range of foreign exchange options (puts and calls) with different strike prices. In doing so, we used option volatility data from the time before the SNB’s announcement to avoid hindsight bias.
Based on this analysis, we concluded that ex-ante, the probability of the Swiss franc appreciating by more than 18 percent over the course of a month was much lower than the probability of an individual being killed by an asteroid over the course of a lifetime.
