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Long-Term Capital Management (LTCM)

Long-Term Capital Management was a highly leveraged hedge fund that specialized in relative-value and convergence trades. The basic idea was often to identify securities whose prices had diverged from historical relationships and position for those differences to narrow. During the 1998 market crisis, many of those relationships moved in the opposite direction. Investors sought liquidity and safety, spreads widened, and positions that had appeared diversified began losing together. Leverage amplified relatively small pricing differences into very large changes in fund equity. At the same time, market liquidity deteriorated, making it difficult to exit positions without affecting prices. A private recapitalization by major financial institutions was coordinated with the involvement of the Federal Reserve Bank of New York. LTCM remains a classic example of leverage, correlation changes, liquidity risk, and model/tail-risk assumptions interacting at once. The key lesson is that low observed volatility is not the same as low risk.