## CHAPTER 2 — Hedge Funds and Financial Stability

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**Canonical URL:** [CHAPTER 2 — Hedge Funds and Financial Stability](https://www.imf.org/-/media/files/publications/gfsr/2026/october/english/ch2sum.pdf)

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### Sector size, structure, and key statistics
- Hedge funds now hold about $13 trillion in assets, more than three times their 2013 level.
- Gross notional exposures have reached about $40 trillion.
- Analysis uses granular data on more than 25,000 hedge funds.
- The sector is highly concentrated: a small number of fund managers account for a large share of assets under management.
- Leverage is concentrated in a few strategies and is obtained primarily from the largest dealer banks.
- End investors are highly sensitive to fund performance, increasing the potential for synchronized investor withdrawals.

### Market behavior in normal times and during stress
- In calm markets, hedge funds tend to trade against price movements, supporting liquidity and price discovery.
- The stabilizing role of hedge funds weakens under market stress, especially for smaller funds.
- Key vulnerabilities that can amplify price dislocations and liquidity strains during stress:
  - Leverage.
  - Fragile investor funding.
  - Crowded trades and increased portfolio similarity, heightening the risk of herding.
- Leverage, crowded positions, and correlated investor redemptions can trigger synchronized deleveraging and asset sales.
- In stress episodes, equities held by more vulnerable funds experience:
  - Sharper price declines.
  - Greater volatility.
  - Amplified declines particularly when high leverage is combined with crowded positions or correlated investor withdrawals.
- In foreign exchange markets, crowded and leveraged carry trades can unwind rapidly, amplifying volatility and spilling over into other asset classes.

### Spillovers to banks and broader markets
- Stress can spread beyond the hedge fund sector when adverse shocks to hedge funds spill over to large dealer banks that act as prime brokers.
- These spillovers are more pronounced for banks with riskier and more leveraged clients.
- Hedge funds can amplify the effect of global risk shocks on equity prices, especially in markets with a larger hedge fund presence and thinner liquidity.

### Policy recommendations and resilience measures
- Enhance surveillance to monitor systemic risks arising from the hedge fund sector.
  - Close data gaps, including on:
    - Leverage.
    - Derivatives exposures.
    - Securities financing transactions.
    - Prime broker relationships.
    - Investor redemption arrangements.
  - Strengthen cross-border reporting and information-sharing arrangements.
  - Conduct systemwide stress tests and scenario analysis to identify vulnerabilities and amplification channels before they materialize.
- Calibrate prudential measures to the nature and source of underlying vulnerabilities while preserving hedge funds’ beneficial market roles.
  - Where risks arise from potential synchronized deleveraging across many funds, consider activity-based measures, including stronger collateral management.
  - Where risks are concentrated in specific firms or exposures, consider entity-based tools such as risk-based leverage limits and large-exposure limits.
- Supervisors should ensure that prime brokers maintain robust counterparty risk management.
- Central banks should maintain credible, targeted, and operationally ready backstops to address severe dysfunction in core financial markets.
- Foster international cooperation to promote consistent implementation and limit regulatory arbitrage across jurisdictions.

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2026/october/english/ch2sum.pdf_