AC948 Case Studies in Financial Environments Lecture 1

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AC948 Case Studies in Financial Environments
Lecture 1

• Yuval Millo, AFM, U. of Essex

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Why is important to study cases?

• Cases studies can explain phenomena that would be
  extremely expensive or even impossible to
  replicate through experiments.
• Market crashes (there is an indefinite number of
  factors involved, frequently vital parts of the
  information are missing)
• Sometimes the particular cases are of historical
  significance
• Started a new trend (junk bonds, hostile
  takeovers)
• Changed the historical narrative of the markets

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How do we learn from case studies?

• The information is very particular and it is
  difficult to generalise
• How to produce valid assumptions using case
  studies.
• Compare with established hypothesis from the
  literature. This may add details to our
  understanding
• Compare with regulatory, policy-related and
  commercial material. These types of knowledge are
  oriented towards decision making and therefore
  close the type of material that is likely to be
  produced in case studies.

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Why are case studies important for the study of
financial environments?

• It is very difficult to simulate events because
  of scale, secrecy, for example. So, frequently
  the only way to learn how financial environments
  really work is through case studies.
• Case studies are less committed to a single
  discipline than other ways of acquiring research
  information.
• financial environments themselves are affected by
  a variety of disciplines.
• Different disciplines study financial
  environments and case studies can serve as a
  cross-disciplinary currency.

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Why is it important to study failures?

• To improve future performance of the market
• In failure, mechanisms that are hidden in normal
  activity, are exposed
• So, study of failures is important from both
  academic and business-oriented perspectives.

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How to study such cases

• What is the background?
• What are the structural characteristics
  technology, governance
• Who are the principle agents involved
• The case
• What were the factors that led directly to the
  failure
• Implications of the failure
• Structural changes (rules, practices)

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The Black-Scholes pricing model

• The model produces options prices. Or, given the
  present price of a contract, the model evaluates
  how risky a certain options position was.
• The model quantified risk in effect, made it
  equally indisputable as prices

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Theory behind the model

• No-arbitrage - cash flow generated by a
  risk-free portfolio would be identical to the one
  generated by a risk-free interest bearing
  account.
• By equating the option-security portfolio to the
  interest bearing account, the options
  theoretical price was discovered.
• Same equation gives the ratio between the amounts
  of security and amount of option that are
  risk-free.

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Reading for next week

• What to read for the second meeting?
• First two chapters from When genius failed
• Chapter 2 from Inventing Money