Browsing in the bookstore of a business school is always interesting. You get a sense of what students want to read and what faculty feel they should read. There are the usual showpiece classic texts beyond student means, and low-price ‘quickie’ books much disdained by their professors. During one such foray into a bookstore recently, I chanced upon Duffie and Singleton’s Credit Risk, more specifically a well-worn paperback version of the 2005 monograph. I picked it up and thought of old friends and old times.
We were a diverse group appearing for the qualifying exam in the statistics Ph.D. program at Stanford University more than twenty years ago. We came from places like China, Hong Kong, Korea, Germany, Israel, India, and the US. Our abilities and interests ranged from abstract mathematics to computer programming, from clinical trials to stock markets. We were hunting for dissertation advisors and thesis topics.
Receiving serious consideration from many of us was the Graduate School of Business (GSB) at Stanford and the scary, sophisticated things underway there in the guise of probability theory. This was a subject that caused me more than a little grief in my courses and I duly steered myself more towards other areas. But several of my classmates felt the call and signed up for Professor Darrell Duffie’s course at GSB. They told the rest of the rapid transitions from rigorous theory to financial applications and vice versa. They told us of difficult assignments and the fear of failure – in short, a typical Stanford experience.
But times were such. Using deep mathematics like stochastic calculus, financial instruments like credit default swaps were being designed and analysed. The future – yet to come – was to be somewhat ambivalent about all that. Today, decades and several financial crises later, thousands of miles away, re-reading the topics in Credit Risk brought back the excitement of those adventurous times and the care and caution we perhaps should have all had.
Other times … Applying financial technology to the bustling practical world of retail consumer finance (think credit cards and personal loans) is a challenge. GE, particularly GE Capital, is a commercial organization with a firm determination to stay ahead of the competition. As scientists in the company’s R&D wing, GE Global Research, we were conscious of the need to make money – or at least not lose money – while taking advantage of the latest advances in finance research.
Ten years ago, much of this research was focused on understanding correlations. Correlations, be they between assets in a portfolio or between products being sold together, are complex beasts. They ebb and flow with time and external events; they indicate empirical linkages that often seem to have no fundamental explanations in terms of asset quality.
To say that we were struggling was a bit of an understatement. Work from several institutions pointed to techniques such as copulas, and we duly tried many such techniques out. (One of the interns working with us then went on to become a star in academia based on his thesis on such matters.) While the theories were elegant and often quite beautiful, they seemed to be cavalier about crucial aspects of correlations between actual assets. Reading chapter 10 of Credit Risk now is a sobering experience.
Most experts today believe that we need a new generation of both mathematical as well as financial innovation to sort all this out. This is a relief for us practitioners (perhaps we weren’t that stupid after all?) and distressing at the same time (“so if the folks at Stanford don’t know what is going on, are we at GE on a wing and a prayer?”) Clearly there is still much to learn.
At the MYRA School of Business in Mysore, life goes on these interesting times. We must be deep and rigorous in our teaching and research, yet we must ensure that it reflects the complexity of real enterprises. We must promote entrepreneurial growth and shareholder value, while steering clear of dubious ethics and financial excesses. We must create a new generation of capable and knowledgeable managers, who are at the same time responsible citizens and leaders.
This will not be easy, but we will be wrong not to try. Along the way, we will tell you what we are finding out and learning. In turn, do tell us your thoughts. Connected, we can accomplish much. Together, we can do more.
Dr. Abhinanda Sarkar
Associate Dean and Director of Research
MYRA School of Business
November 3, 2014