Price Dislocations and Risk Management: Lessons from a Large Options Trading Loss

Abstract

On May 8, 2007, the largest trading loss thus far reported in Sweden was announced by Carnegie Investment Bank, caused by a revaluation of the bank’s options portfolio. Among consequences, the bank’s CEO was forced to resign, the bank was fined a maximum penalty from the Swedish FSA, and three option traders were accused of market price manipulations and exploitation of inefficient internal procedures. Using unique data from the Swedish Economic Crimes Bureau, this paper provides a hands-on account of how market price were dislocated and shows the actual trading patterns behind the dislocations. Internal procedures at the bank failed and the paper provides some important lessons regarding operational risk management practices.