POLITICAL RISK ANALYSIS IS BOOMING!

AM | @agumack

"... political risk analysis is booming" — Huw van Steen

Political risk is back! That's great news for those of us who find the issue relevant—especially when it comes to cost of capital calculations. In early 2015 I took part in a symposium at Institut des Sciences de l'Homme in Lyon about the great Italian economist/thinker Ferdinando Galiani (1717-1787), who in his book Della Moneta (1751) established an explicit link between the supply of credit and the quality of governance [see]. I have also constructed an 'Index of Checks and Balances' [see], which I compared to each country's stock of local currency bonds in terms of GDP.

Unsurprisingly, the cost of capital tends to be lower in well-run countries (the Nordics in particular). Now one member of the EU Business School Finance Club will write a thesis about these issues. Great news!

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Motivated by recent political events, the Financial Times has been publishing some interesting articles on political risk. I will single out Huw van Steen's March 15 piece and Gillian Tetts' take on Bridgewater Associates' analysis of populism (*). You may also want to watch this video by the FT. (Gillian is back with a fresh piece on political risk in Silicon Valley). Do you have ideas/suggestions for a political/country risk index? Can we harness the diversity of our student base to get a sense of perceptions of political risk in Kazakhstan, Colombia and ... the United States?

(*) Huw van Steen: "An emerging market toolkit is now essential for investors in the West", Financial Times, 15 March 2017; Gillian Tett: "Populism emerges as a key economic influence", Financial Times, 23 March 2017.
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MORE STORIES ON QUANTS

AM | @agumack

"... backward looking data can fizzle out" — Robin Wigglesworth

There are three very interesting stories on quants in today's FT (make it four if you count John Authers' piece on smart beta). Robin Wigglesworth —who writes more persuasively on quants than on markets and interest rates— mentions a Two Sigma competition in which contestants are given three months to code a trading algorithm based on four gigabytes of financial data. The winner will pocket $100,000 (*). His 'Big Read' piece is also pretty interesting, as he mentions the 2007 débâcle of Goldman Sachs' Quantitative Investment Strategies. The sector has since then recovered, and assets under management for quantitatively-oriented hedge funds are approaching the $1 trillion mark. (Don't miss the short section on GS' alternative risk premia unit).

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Can we possibly use some of this material in class? Yesterday in the Financial Markets exam I had students estimate two entry points using 20-day and 50-day moving averages. Shortly I'll be testing some (extremely simplified) exercises with 'Natural language processing'. We could take speeches from the Fed chair, or a sample of research reports. Here's Dennis Walsh of Goldman Sachs:

Goldman's algorithms can systematically look for verbal clues from analysts on a call that might indicate whether they were pleasantly or unpleasantly surprised at the results—and therefore upgrade their outlook in response. "There's a tendency towards praise to keep in management's good books, but only marginally. If 20 out of 30 analysts say 'great quarter' then it probably was".



(*) Robin Wigglesworth: "Lessons from the quant quake" and "Funds adopt novel methods to hunt down new talent"; John Gapper: "Technology outsmarts the human investor". See also John Authers: "Popular 'smart beta' strategies reveal their true value in trial". All from the March 9 issue of the Financial Times.
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THE OUTSIDER

AM | @agumack

"Des volumes de cette importance ne passent pas inaperçus" — François-Xavier Demaison

I watched L'Outsider over the week-end. This is the movie about Société Générale trader Jérôme Kerviel, whose bets on the Euro Stoxx 50 (traded on Eurex), Xetra DAX (traded on Eurex) and FTSE 100 (traded on Euronext.liffe) cost €4.9 billion to the bank in January 2008. We discussed this stunning affaire in Ethics in the Financial World. I thouroughly enjoyed the movie. Because Kerviel was well-versed in all things IT, he was able to conceal a sizeable portion of his trades. Who is to blame? Christophe Barratier, the film director, skillfully leaves that question open (*).

Not long before the implosion of Kerviel's trades, in October 2007, Eurex complained to Société Générale that Kerviel's positions amounted to 30% of open interest in DAX futures. In the movie, members of the trading desk refer to futures positions as Spiel. There was obviously a massive failure of compliance—although the bank had a strong reputation in that regard. What also transpires is a world totally dominated by ... men. Apart from Kerviel's lover, his mother and a strong-minded compliance official who shows up towards the end, women play no role in the movie. And this was precisely part of the problem.

Too much testosterone in the (trading) room!

(*) "Kerviel n’aurait jamais dû être trader", L'AGEFI, 22 June 2016

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