What can mother nature teach us about managing financial systems? – Andrew Lo

Read the full post at The Christian Science Monitor

Andrew W. Lo is the Charles E. and Susan T. Harris Professor, a Professor of Finance, and the Director of the Laboratory for Financial Engineering at the MIT Sloan School of Management.

At last, Obama stands up to the big banks — Simon Johnson

MIT Sloan Prof. Simon Johnson

From MarketWatch

Not surprisingly, at least some people at the Securities and Exchange Commission have reacted negatively — this is stepping onto their turf, after all. And the lobbyists are, naturally, out in full force.

But with sufficient White House willpower, the administration can see this through. What is needed is a change in the rules set by the Department of Labor, which has jurisdiction over retirement-related issues.

No doubt industry defenders will claim that current practices benefit small investors — a point disputed directly by the CEA. The broader and more interesting question is: Where are the statesmen in the financial industry? Where are the leaders who push for a race to the top, by better serving their clients’ best interests?

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Flash Crash jitters: What to know about high-speed trading before the next market disaster strikes — Andrei Kirilenko

MIT Sloan Professor Andrei Kirilenko

MIT Sloan Professor Andrei Kirilenko

From The Conversation

Ask people on the street what mental image they associate with the words “stock exchange,” and you’ll likely hear about a large imposing building in the middle of New York or Chicago. Inside the building there is a huge space crowded with traders in multicolored jackets screaming and gesticulating to each other.

Until ten years ago, that would have been a pretty accurate description of a stock exchange. Today, however, almost all trading is done by algorithms firing digital commands traveling near the speed of light to rows upon rows of computer servers sitting in nondescript suburban warehouses.

The transition from human to electronic trading came with the promise of using faster and cheaper technology to drastically lower the costs of trading shares and to make it much easier to determine the most up-to-date prices for all market participants (commonly known as price discovery).

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Diversity and markets — Evan Apfelbaum

MIT Sloan Asst. Prof. Evan Apfelbaum

We usually think of ethnic diversity as a matter of social policy, not a factor that could impede market bubbles. But new research by me and a team of colleagues suggests a surprising new reason to consider diversity as a hedge against speculative bubbles: in two studies, we find that markets comprised of ethnically diverse traders are more accurate in pricing assets than ethnically homogeneous ones. Our paper, which came out Nov. 17 in Proceedings of the National Academy of Sciences (PNAS), finds that ethnic diversity leads all traders, whether of majority or minority ethnicity, to price more accurately and thwart bubbles. The reason isn’t because minority traders had special information or differential skills; rather, their mere presence changed how everyone approached decision-making.  Traders were more apt to carefully scrutinize others’ transactions and less likely to copy others’ errors in diverse markets, and this reduced the incidence of bubbles.

To conduct our research, we constructed experimental markets in the United States and Singapore in which participants traded stocks to earn real money. We randomly assigned participants to ethnically homogenous or diverse markets. We found that markets comprised of diverse traders did a 58 percent better job at pricing assets to their true value. Overpricing was higher in homogenous markets because traders are more likely to accept speculative prices, we found. Their pricing errors were more correlated than in diverse markets. And when bubbles burst, homogenous markets crashed more severely.

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Containing Contagion: ‘There is no replacement for good macro-fundamentals’ — Kristin Forbes

MIT Sloan Prof. Kristin Forbes

What began as a singular sovereign debt problem in Greece in 2009 quickly spread to the rest of Europe. First Ireland; then Portugal and Spain and Italy. Today—only three years after the first signs of trouble—virtually all Europeans have felt the destructive effects of the euro zone turmoil, and its impact is being felt around the world.

Contagion, a phenomenon where financial tumult in one country or region spreads to another country, is now a fact of life. The globalization of finance has, in many ways, made contagion inevitable. The world has become much more integrated through trade, investors, and banks, and these ties have caused countries’ financial markets to move together more closely during good times and bad. Read More »