Quantitive Risk Analysis Raises Red Flags with Madoff Funds, says Riskdata
A quantitative risk analysis of Bernard Madoff’s returns and the risk profile of his “split strike conversion” option trading strategy would have uncovered red flags in Madoff’s advertised returns and helped in fraud detection, according to a report from Riskdatareleased today.
Riskdata’s analysis identified two main red flags in Madoff’s returns and in its risk profile characteristics as compared to funds. First it used the Bias Ratio, invented by Adil Abdulalli of Protégé Partners and available in Riskdata’s analytic suite, which can detect smoothing of returns and possible performance manipulation. While Madoff’s funds did not report their returns to the Hedge Fund Research (HFR) database, Riskdata found Madoff’s series of returns is identical to that of one of his feeder funds, Fairfield Sentry Ltd, managed by Fairfield Greenwich Group.
In the HFR database, Fairfield Sentry is classified as an equity hedge category, which contains 2,290 funds. Based on Riskdata’s analysis, Fairfield Sentry’s Bias Ratio ranges between six-and-seven, when equity hedge funds are mainly one to three. Another red flag here is that the acceptable range for the Bias Ratio depends on the liquidity of the traded securities: up to three for very liquid funds and up to 20 or 30 for the most illiquid ones. Given that Madoff claimed that he traded stocks from the S&P 100 index and index options, all being quite liquid securities, this is proof that his Bias Ratio should have been above three, stated Riskdata in its report.
Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio
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