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.