Mayfair, the centre of the London's hedge fund industry, is alive with speculation that one of the world's major hedge funds is set to collapse, bringing a fresh wave of selling and volatility on the world's stock markets.

The fevered talk that many of the world's alternative investment funds are in dire trouble drew a formal response yesterday from Citadel Investment Group, the one-time $40 billion (£23 billion) fund that had to dispel rumours it had been forced into emergency borrowing.

Another giant of the US industry, Fortress Investment Group, today admitted that two of its major investments are in trouble while Highland Capital Management, a hedge fund group with about $40 billion under management, admitted it is having to close two funds.

The latest tremors in the industry follow weeks of speculation that giant New York hedge fund Atticus Capital has been struggling.

"It will be game over for one of the major hedge funds soon, judging by the huge amounts that have been withdrawn from the market, which in turn has been causing the massive [stock-price] movements we are seeing at the moment," said a well-placed Mayfair source.

"We are on course for the next phase of the crisis as the big hedge funds begin to melt down leading to the furthering cratering of stock prices.

"The amazing thing is that we have not seen one of these big hedge funds go down. It is not a case of if one of the big funds goes down, it is a case of when. The question is when and who will it happen to."

The problems at Citadel and Atticus have spooked the industry. Atticus co-chaired by banking heir Nat Rothschild, a friend of new Business Secretary Peter Mandelson has grabbed the headlines in the UK.

Its Canadian founder, Tim Barakett, has allied with his long-time friend Chris Hohn of TCI fund to destabilise the company running the Frankfurt Stock Exchange.

Atticus last month admitted that its funds under management have fallen by more than $5 billion, or 30%.