FRM Part 1, Book 1, Chapter 9 - Learning from Financial Disasters -Model Risk – LTCM

In this video, we analyze the Long-Term Capital Management (LTCM) collapse, one of the most famous hedge fund failures in financial history and a key FRM exam case study. This lesson is based on FRM Part 1 – Book 1, Chapter 9: Learning from Financial Disasters, and focuses on the risk management failures that led to LTCM’s downfall.

Founded in 1995, LTCM delivered exceptional returns until 1998, when the Russian debt crisis triggered severe market disruption. Despite its reputation and the involvement of prominent figures such as Myron Scholes and Robert Merton, the fund relied heavily on leverage and relative-value convergence trades. When market conditions deteriorated, spreads widened instead of converging, liquidity disappeared, and losses accelerated rapidly.

The episode highlights several key risk management lessons emphasized in the FRM curriculum, including the dangers of excessive leverage, liquidity risk, correlation breakdown, model risk, and limitations of Value-at-Risk (VaR). LTCM estimated a 10-day VaR of about $330 million, yet losses exceeded $1 billion, demonstrating how tail risk and stressed market conditions can overwhelm traditional risk models.

This case remains one of the most important examples used in FRM exam preparation to illustrate market risk, liquidity risk, systemic risk, and risk management failures in financial markets.

All visuals, voice, and narration are original creations by Braia Renata

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