JWM Partners assumed all positions correlate perfectly in worst-case crises.

Evidence

That was the lesson that LTCM’s successor fund, JWM Partners, drew from its predecessor’s crisis. In JWM Partners’ risk model, all the fund’s positions, no matter how diversified geographically or how unrelated in asset type, are now assumed to have correlations of 1.0 “to the worst event” (Meriwether interview). In other words, it is assumed that in an extreme crisis all the fund’s positions may move in lock-step and adversely, even those positions that would in the abstract be expected to rise in relative value in a crisis (in other words, the cases in which it holds the more liquid or more creditworthy of two instruments and has a short position in its less liquid or less creditworthy counterpart). — Donald MacKenzie, An Engine, Not a Camera, 1230

Categorization

• CANDY: The counterintuitive idea that even hedges are assumed to fail — assuming perfect correlation to the worst event, even for positions designed to rise in a crisis — is a striking, easily-retold anecdote.
• SHARE: A risk-modeling enthusiast would appreciate this radical ‘correlation to worst event = 1.0’ assumption as evidence of how trauma rewrites risk engineering.