ACADEMIC ROUNDTABLE
SEFTON – Of course. However some
judgement is always required in how to
apply theoretical models. It is all too
easy, with the benefi t of hindsight, to see
that mistakes have been made. Th e
point here is that the goals of theoretical
models and business models are very
diff erent. Th eoretical models aim to
describe and explain a complex world.
Business models set out to act as a guide
through this complex world. Th e former
must accommodate the complexity; the
©ART GLAZER
latter must be robust to it. Too often this
distinction is overlooked.
One failure does need highlighting
“Ratings agencies provide a very useful
though. Ratings agencies provide a very
useful service to investors. However it is
service to investors. However it is clear that
clear that their models failed abysmally
to account for the systemic nature of the
their models failed abysmally to account for
risk in many structured products. In
November 2007, the number of
downgrades already exceeded 2,000. Yet
the systemic nature of the risk in many
by 2008, this number had soared to
11,000 downgrades of which 31% had
structured products” SEFTON
been previously rated as AAA. Investors
rely on these ratings to monitor their
risk and shareholders rely on them to
bit of academic whimsy it might not matter but anyone who has glanced assess the exposures taken on by
at a bank’s balance sheet in the last year will know that industry has been corporates. Our capitalist system is
contaminated by the same mind-set. Likewise, if you look at long-short premised on the ability of shareholders
mathematics in quantitative investment risk packages as used by countless to monitor their companies; systematic
quant hedge funds, you will fi nd the same thing. What is needed is to errors in ratings undermine this.
bring back some notion of supply/demand back into fi nance so that
investors face sloped, rather than fl at, curves. Attempts to model liquidity
and market impact are a move in the right direction. TAPLEY – What can academia
contribute to practical risk
management?
TAPLEY – Has good theory been badly applied by politicians,
regulators, and members of the fi nancial industry in general? SARNO – Academia has always made a
major contribution. Th e fi nancial
SARNO – Yes. Politicians, regulators, fi nance practitioners all share industry employs economists,
responsibility for the current crisis. In theory, we know well how mathematicians, physicists, engineers
regulation and macro-economic policy should be counter-cyclical to and IT experts who have made
stimulate activity when the economy is in a recession, while containing important contributions to applied
bubbles in asset markets when times are good. But which central banker research in risk management. Th ey have
or politician wants to moderate growth when things are going well? I developed new methods of evaluating
fi nd the emphasis on regulation unnecessary at this stage. Th ere is no risk and estimating probabilities of
rush to regulate markets now; rather there is a need for refl ection and defaults, which constitute standard
learning, while thinking of how to change the regulatory structure once practice in the industry. What is needed
the crisis is not so fresh in our minds. I do not think regulation is the is closer integration between risk
solution to the crisis; it never was. managers and academia. Th e intellectual
WWW.CFAUK.ORG PROFESSIONAL INVESTOR 7
08-1108-11 academic roundtable.indd 7academic roundtable.indd 7 1/6/091/6/09 11:25:3711:25:37Professional Investor Summer 09.9 9 4/6/09 15:40:43
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