Inventing Money: The Story of Long-Term Capital Management and the Legends Behind It

Nicholas Dunbar covered derivatives for Risk magazine, and he writes about Long-Term Capital Management with more technical detail about the actual positions than any other account of the episode. Roughly the first half is intellectual history: Bachelier, the development of option pricing by Black, Scholes and Merton, the growth of the swap market, and the spread of arbitrage pricing methods through the trading desks of the 1980s.

The second half covers the fund itself, from its founding by John Meriwether in 1994 through the collapse and Federal Reserve-organised recapitalisation in September 1998. Dunbar explains the trades: convergence positions in European government bonds ahead of monetary union, swap spread trades, on-the-run against off-the-run Treasuries, the Royal Dutch and Shell pair, merger arbitrage, and the large short position in long-dated equity index volatility that the fund built as its capital base grew. He shows how each individual position was defensible and how the portfolio as a whole amounted to a single bet that liquidity premia would narrow.

Dunbar's argument is that the models were not the failure. The fund's own risk system reported the positions accurately given its assumptions about correlation and about the availability of financing. What the system did not capture was that other desks had copied the same trades, that the fund's size meant it could not exit without moving prices against itself, and that its lenders would withdraw collateral terms precisely when the marks moved. Roger Lowenstein's When Genius Failed covers the same events with more character and less mathematics, and the two complement each other. Dunbar wrote before the 2008 crisis demonstrated the same mechanism at much larger scale.