Sponsors include Cambridge Commonwealth Trust,. Charterhouse Trust, EPSRC .... Time series plot of JP Morgan. Emerging Markets Bond ... crisis drives investors away from emerging markets globally â .... American Put Value Surface ...
Challenges for the Future in Financial Services
Professor Michael Dempster Centre for Financial Research Judge Institute of Management
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Challenges for the Future in Financial Services • • • • • • • • • • •
The Centre for Financial Research Finance in the 20th Century Equities Fixed Income Emerging Markets Investment Derivatives Corporate Finance Real Options Corporate Risk Management Financial Regulation © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Partners Past & Present
LEHMAN BROTHERS
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Centre Personnel • Professor M A H Dempster, Director
• Director of Research and Professor of Management Studies
• Dr Richard Barker
• University Lecturer in Accounting
• Dr Robin Chatterjee
• University Lecturer in Accounting
• Dr Gishan Dissanaike
• University Lecturer in Finance
• Dr Bart Lambrecht
• University Lecturer in Finance
• Dr Elena Medova
• Senior Research Associate
• Dr Alex Taylor
• Lecturer in Finance
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Centre Personnel • 3 PostDoctoral Research Associates • Dr Francesco Moresino (Swiss National Science Foundation) • Dr Darren Richards (Algorithmics/DTI) • Dr Giles Thompson (Algorithmics/DTI)
• 23 Doctoral Students in Finance • Sponsors include Cambridge Commonwealth Trust, Charterhouse Trust, EPSRC, ESRC, EuroPlus, ORS, Trinity College, UniCredito
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Executive Education • Regular Risk Management courses (Cambridge, London and New York) 1996, … in association with Carnegie Mellon University • New RiskLab Cambridge/Algorithmics Risk Management courses in London, Toronto, Athens, Johannesburg, … in association with Algorithmics • New Capital Markets courses in London, Istanbul, Singapore, … in association with Brady and NM Rothschild
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Finance through the 20th Century • 1900 • 1929 • 1944 • 1953 • 1957 • 1965
Bachelier produces the first model for stock prices Stock market crash - Dow Jones lost 12.9% of value - and depression Bretton Woods fixes exchange rates Markowitz thesis on diversified portfolio management Modigliani-Miller paper on capital structure Capital asset pricing model of Sharpe et al
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
• 1973 • • • •
Breakdown of Bretton Woods CBOT opens option exchange and Fisher Black and Myron Scholes derive their option pricing formula 1987 Black Monday - Dow Jones lost 22.6% of value 1990 Japanese financial collapse 1993 ERM breakdown with large speculative profits 1994-8 Major losses on derivatives involving operational risks including Barings ($1.4bn), Sumitomo ($1.8bn), Metalgesellschaft ($1.9bn) and LTCM ($3.6bn)
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Visit of Nobel Laureate Professor Myron Scholes (July 2000)
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Dow Jones Industrial Average 12000 10000 8000 6000 4000 2000 0 1900
1920
1940
1960
1980
2000
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
US Price-Earnings Ratio, 1881-2000 50 40 30 20 10 0 . . 2000 11881 118. . 235 352 469 1929 586 703 820 937 1054 1171. .1288 1405
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
World's Stock Exchanges (1999) Exchange Market Cap. ($bn) Volume ($bn) NASDAQ 5,204.60 10,467.40 NYSE 11,437.60 8,945.20 London 2,855.30 3,399.40 Paris 1,502.90 2,892.30 Tokyo 4,455.30 1,675.60 Frankfurt 1,432.20 1,551.50 Toronto 789.2 357.4 © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Who Owns Shares?
Individuals
US
France
UK
Germany
50%
31%
18%
6%
Others: Corporations and Pension, Insurance, Mutual and Trust funds © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Richard Barker
Determining Value Valuation Models and Financial Statements Financial Times-Prentice Hall (Spring 2001)
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Research in Empirical Finance Dr Gishan Dissanaike Research Group: Imran Markar, Armen Papazian, Marc Sardy, Shiyun Wang, Linor Yechiel
• US and UK stock market behaviour • Do stock markets overreact? • Are contrarian portfolio strategies profitable?
• Corporate finance in East Asia before the 1997 crash •
Funding: ESRC, Institute of Chartered Accountants of England & Wales, Institute of Chartered Accountants of Scotland, Cambridge Commonwealth Trust and Charterhouse Trust
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
100
200
300
400
Time series plot of Morgan Stanley Emerging Markets Equity Index
31/12/1987
31/12/1991
31/12/1995
31/12/1999
T im e
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
0.06
Time series plot and histogram of daily returns
40
Russian crisis
0.02
0.04
Japanese crisis
-0.04
-0.02
0.0
Percent of Total
30
20
-0.06
10
0
01/01/1988
01/01/1992
01/01/1996
01/01/2000
-0.06
-0.04
-0.02
0.0
0.02
0.04
m sem ei.r
Time
Returns
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
0.06
120
140
160
180
Time series plot of JP Morgan Emerging Markets Bond Index+
0
7
0/
2 1
1 0/
2 / 7 1 1 0/ 9 2 / 1 1 9 1 0 / 9 72/ 7 1 9 1 0 / 9 82 / 1 1 9 1 / T
i
m
e
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
0.05
Time series plot and histogram of daily returns
-0.05
0.0
Percent of Total
Russian crisis
6
0
4
0
2
0
0
0
7
0/
2 1
2 0/
2/ 7 1 2 0/ 9 2 / 1 19 2 0 / 972/ 7 1 9 2 0/ 9 82 / 1 19 2 / T
i
m
e
-
0
.
0
05
eReturns m
.
0
0
b
i .
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
. r
0
5
Credit Risk Alex P Taylor
The Russian crisis of August 1998
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
• SPREADS! - High spreads till 1995 due to uncertainty over Russia’s ability and willingness to service its debt • Russia implements a series of reforms – spreads decline. • July 1996 Yeltsin re-elected which increased stability and reduced spreads further • Zenith of Expectations in Jan-Sept 1997 • Oct 97 Russia’s problems start to mount – spreads rise + Asian crisis drives investors away from emerging markets globally – Russia downgraded by several credit agencies • 1998 IMF gives out loans but in August 1998 it’s clear it’s not enough © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Russian Default 31.7.98
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
• Bank regulators are having apprehensions about the adequacy of current models for emerging markets • Researching new models of credit risk that meet these kind of problems
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Annual Investor Returns of Long-term Capital 50%
0%
'95
'96
'97
-50%
-100%
It is a story as old as the history of financial debacles: a gradual loss of confidence eventually cascading into a full-scale rout
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Total Return Indices 1802-1997
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Total Real Return Indices 1802-1997
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
World Equity, Derivative And Credit Markets (1996) US TNs Equity markets 14.1 Loan Markets 11.8 US Domestic (C&I Real Estate) 1.5 UK domestic business 1.3 German domestic business 1.0 Japan - all domestic lending 5.1 International facilities 2.9 Bond markets Domestic local government Domestic corporate issues Other dom non govt issues International non govt issues Derivative markets
6.1 1.2 1.9 2.1 0.9
Sources: Salomon Euromoney Bloomberg Federal Reserve Bank of England Bundesbank Chase Chemical c.55.0
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Prototype EGAM Global Structure US
Japan
Emerging Markets
European Union
UK
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Prototype EGAM Area Structure (UK, US, Japan, Euro Zone) PSBR
Nominal GDP Price Inflation
Economic Model
Real GDP
Zero Yield Curve
Capital Markets Model
Pension Liability Models
Cash
Fixed Income
Equities
Benefits for DB
Wages and Salaries
Currency Ex. Rates
Contributions for DC and DB
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Other Areas
Strategic Financial Planning Asset-Liability Statistical Model
ALM Optimization Model Adaptive Filtering Scenario Tree
Market Data
Estimation/Calibration
Simulation
Generation
Optimization Sequential Sampling
Visualization
Manager
Recommended Decisions
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Computational Learning for FX Trading Without Trading Costs
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Monthly returns at 8bp slippage
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Derivative Markets (June 1998)
Source: BIS
Notional ($bn) Foreign Exchange Contracts 18,719 Forwards and FOREX Swaps 12,149 Currency Swaps 1,947 Options 4,623 Interest Rate Contracts 42,368 Swaps 29,363 FRA's 5,147 Options 7,858 Equity-Linked Contracts 1,274 Forwards and Swaps 154 Options 1,120 Commodity Contracts 451 Gold 192 Other 259 Total 69,912
Gross market values ($bn) 799 476 208 115 1,160 1,018 33 108 190 20 170 38 10 28 2,427
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
American Put Value Surface
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Local Volatilities for FTSE 100 Index
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Cross Currency Swap Value Surfaces
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Cross Currency Swap • •
Domestic Fixed Rate=10%, Foreign Fixed Rate=10% Exact value : 0 Wavelet method of lines Discretization
Value
20 x 8 x 8 x 8 20 x 16 x16 x16 20 x 32 x32 x 32 40 x 64 x 64 x 64 100 x 128 x 128 x 128 160 x 256 x 256 x 256
-0.00082 -0.00052 -0.00047 -0.00034 -0.00028 -0.00025
Solution time (seconds) 1.2 6.54 40.40 410.10 4240.30 53348.10
Explicit Finite Difference Method Value Solution time (seconds) 20 x 8 x 8 x 8 -0.00109 0.28 20 x 16 x16 x16 -0.00101 1.70 20 x 32 x32 x 32 -0.00074 16.82 40 x 64 x 64 x 64 -0.00058 188.10 100 x 128 x 128 x 128 -0.00046 2421.6 160 x 256 x 256 x 256 -0.00038 33341.8
•
Speedup : 81.3 © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Research Interests of Robin Chatterjee • Accounting for derivatives • In particular, issues relating to Measurement and Reporting Risk of Financial Instruments, over which there is considerable current controversy and debate, primarily between banks and the International Accountancy Standard Setters
• Empirical work in the field of mergers and acquisitions. • Recent work has focused upon the post-merger performance of acquirers, according to whether targets are domestic UK, Continental European or US targets • Additionally, our research is also examining the share price performance of acquirers according to how the takeover is financed e.g. by cash, shares, or a mixture of the two • A further strand of research looks at whether the factors affecting the likelihood of being taken-over have altered in recent times due to various financial innovations © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Corporate Investment under Uncertainty and Competition Bart Lambrecht • Application of real option techniques to solve problems in corporate finance such as: • the timing and terms of takeovers, and the takeover wave puzzle • bankruptcy, insolvency, default and debt reorganization in an oligopolistic market • the interaction between product market decisions and financing decisions • strategic market entry and market exit in an oligopolistic market
• Empirical analysis of dynamic capital structure models using UK panel data • Mortgage default and repossession in the UK (using bivariate duration analysis) © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Real Options • Incorporating strategic behaviour into corporate project investment analysis and risk management • Incorporating debt financing into the real options framework • Empirical application and evaluation of real option models
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Comparison Predicted Copper Prices with Actual Equity Prices 160 140
Copper Prices
120 100 80 60 40 20
337
323
309
295
281
267
253
239
225
211
197
183
169
155
141
127
113
99
85
71
57
43
29
15
1
0
NOBS
Phelps Dodge Share Price Model, 10 yr Forward Curve
10 years prices (Economics Dept.)
Plots of the weekly 10 year forward curve (model), 10 year Rio Tinto Economics Department’s forecast and the Phelps Dodge share price, from 27/12/91 to 14/08/98 © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Spot Price of Crude Oil (1948-2000) 40
Price ($ per barrel)
35 30 25 20 15 10 5
2000
1998
1995
1993
1990
1988
1985
1983
1980
1078
1975
1973
1970
1968
1965
1963
1960
1958
1955
1953
1950
1948
0
Date
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Crude Oil Futures Prices 40 35 30 25 20
Crude Oil Futures Prices
15 10 5
6/18/99
3/20/98
12/20/96
9/22/95
6/24/94
3/26/93
12/27/91
9/28/90
6/30/89
4/1/88
1/2/87
10/4/85
7/6/84
11
4/8/83
Contracts Maturity (months)
6
1
0
1983 - 1999
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Heating Oil #2 Futures Prices 120 100 80 60
Heating Oil Futures Prices
40 20
3/20/98
8/9/96
12/30/94
5/21/93
10/11/91
3/2/90
7/22/88
12/12/86
5/3/85
9/23/83
2/12/82
7/4/80
13 11/24/78
Contrac ts Maturity (Months )
7
1
0
1978-1999
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Unleaded Gas Futures Prices 100 90 80 70 60 50 40
Unleaded Gas Futures Prices
30 20 10
9/10/99
5/8/98
1/3/97
9/1/95
4/29/94
12/25/92
8/23/91
4/20/90
12/16/88
8/14/87
4/11/86
12/7/84
11
Contracts Maturity (Months)
6
1
0
1984-1999
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Integrated Logistics and Financial Planning
Financial & Logistics Models Choose a general strategy For each year Determine policies for: Investment
Growth/Mix of Business Hedging strategy
Financing
Financial & Logistics Models Determine consequences Next Year Measure overall satisfaction
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Case 1
Case 2 X
X
S
S
E
E
Z
Z
Xsp
Xsp
Ysp
Ysp
• Case 1: Storage is the dominating activity • Case 2: Refining is the dominating activity
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Investment Banking Market Risk Management
Target payouts of index option portfolio at four maturities © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
The options available to the replicating portfolio
Maturity Strike
30 1285
90 1300
180 1330
360 1405
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
risk-factor tree generator
RW scenario set
RW
AMPL data-file generator
export data-file
stress-test export script
non-scenario data
per-scenario data
AMPL model
STOCHGEN
deterministic equivalent MPS
Stochastic programming with RiskWatch and STOCHGEN © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
What do we need for aggregation of operational risk? • Structural model of the business Top Management Front Office Treasury & Trading Positioning
Middle Office Market and Credit Risk Analysis
Back Office Operations Trade Processing
Audit Review all areas External & Internal
• Models of processes contributing to operational risk • Information flow control structure / model © Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Business Unit
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
Time series plot of P&L data 2000
(Losses are positive, Gains are negative)
-1000
0
1000
Russian Crisis
01/10/97
01/02/98
01/06/98
01/10/98
Tim e
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
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1 1
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Desk 3
Desk 2
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Desk 1
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Breaking the data into the four trading units Time-Series plots of negated P&L’s
1
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18 0/
90 1
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© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
P&L Risk Estimates Daily Severity 95% GPD Quantile Annual Excess Risk Capital
Firm-level
u=150
Profit & Loss
691.0
24,294
One
601.6
26,345
Two
116.3
2,095
Three
179.2
3,924
Four
71.2
1,350
Trading desks u=130
33,714
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
THE ROLE OF REGULATION IN GLOBAL FINANCIAL MARKETS: THE WAY FORWARD
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
GENERAL THEMES • Objectives of international regulation • Elements of a global regulatory regime • Current institutional and legal framework • Suggestions for reform
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
WHY HAVE REGULATION OF GLOBAL CAPITAL MARKETS? • To Reduce Systemic Risk • Excessive volatility of international capital flows. Price of securities/financial products do not reflect true costs of Risk This creates a negative externality
• Contagion - transmits shocks and crises to other countries’ financial systems • Financial markets are more efficient when risk is priced to reflect its true costs
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
MANAGING SYSTEMIC RISK THROUGH SECURED SETTLEMENTS • • • • • •
Basic Operating Principles of Payments Systems Current Initiatives in Reforming Payment Systems Risk Management in Real Time Gross Settlement Systems Risk Management in Net Settlement Systems Can RTGS and Netting Coexist? Policy Considerations: Shift towards Collateralised RTGS
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
CAMBRIDGE ENDOWMENT FOR RESEARCH IN FINANCE International and interdepartmental research will focus on financial markets and institutions which have re-emerged as prime determinants of microeconomic behaviour and macro-economic performance, addressing: • Theoretical analysis, • Operational realities, and • Global economic consequences of financial behaviour
© Centre for Financial Research, Judge Institute of Management, University of Cambridge www-cfr.jims.cam.ac.uk
