Finance Superstars that are Changing Our World - CISDM Research Day at the Isenberg School Rocks!

Yesterday, at the Isenberg School of Management, we were treated to brilliant talks and discussions at the Center for International Securities and Derivative Markets (CISDM) Research Day!

The event from 11:30AM until 4:30PM was organized by my great Finance colleague, Dr. Mila Sherman.

Two of the talks: "Can Financial Engineering Cure Cancer? A New Approach to Funding Biomedical Innovation" and "Lies my Finance Professor Told Me: Reconciling Efficient Markets and Behavioral Finance via Evolutionary Biology and the Cognitive Neurosciences" were given by the Finance Superstar, Dr. Andrew Lo, of the MIT Sloan School.

Our Isenberg Dean, Dr. Mark Fuller, Associate Dean Dr. Jane Miller,  and the UMass Amherst VCRE, Dr. Mike Malone, all joined us for Dr. Lo's first presentation. It was great to have faculty come from Babson, Suffolk University, and Smith College to this event, as well as several alums, practitioners, and also students. Several of our PhD students in Management Science also came, which was great.

I have heard Professor Lo speak on several occasions because we had hosted him before and I have spoken at various venues with him  in both NYC and Chicago. Mila and I were in the Network Analysis segment of the latter conference which was on Measuring Systemic Risk.

He is brilliant and in his financial engineering and curing cancer presentation (on which I took copious notes) he noted that if we could create a fund of $30 billion we should be on our way to curing cancer - the strategy should be, as in finance, to diversify the portfolio and enable the investigation of multiple pathways with 150 cancer compounds, for example. NIH cannot support all the cancer researchers out there!

Who has not been affected by cancer, whether individually or through having a relative or friend suffering from the disease. Andrew noted that his mother died of cancer and my dissertation advisor at Brown University, Dr. Stella Dafermos, also died of cancer at age 49 back in 1990. She was a genius. We know so much now how cancer and other diseases work at the molecular level and have had amazing drug discoveries such as Gleevec and Avastin but the right investments and financial support are needed. He noted that no new Alzheimer's drugs have been introduced in the past decade!

The business model of pharma is broken and the economic risk has increased. Private equity is not ideal for the financing of drug discoveries. We need to get the funds into the system to finance drug development and use financial engineering and securitization.

He also spoke about orphan (rare) diseases and associated drugs and innovations and that business models for those work - pricing of certain drugs, however, is another issue.

Dr. Lo emphasized: Doing Well with Doing Good . All the Operations Research folks out there will recall one of our profession's themes of Doing Good with Good O.R. (Operations Research).

My research group at the Supernetworks Center at the Isenberg School has written several papers on the pharmaceutical industry with a focus on competitive supply chains. Hence, his first talk was especially  thrilling and intellectually captivating. Our paper: Pharmaceutical Supply Chain Networks with Outsourcing Under Price and Quality Competition, Anna Nagurney, Dong Li, and Ladimer S. Nagurney, International Transactions in Operational Research 20(6): (2013) pp 859-888, focuses on quality issues.  Our paper, A Supply Chain Generalized Network Oligopoly Model for Pharmaceuticals Under Brand Differentiation and Perishability, Amir H. Masoumi, Min Yu, and Anna Nagurney, Transportation Research E 48: (2012) pp 762-780, investigates even the impact of the loss of patent rights and competition from generics.

In his second talk, Dr. Lo  emphasized how insights from evolutionary biology and neurosciences can reveal human decision-making behavior and what it means for financial decision-making as well. I loved the interdisciplinarity of his talks - bringing biological insights to economics and finance. He is a true Renaissance man and incredibly  inspiring. He noted that rationality is the delicate balance between emotion and logic and stated that wisdom of crowds works, unlike the madness of mobs!

I very much appreciated his adaptive market hypothesis and how this concept differs from the efficient market hypothesis. Lo also recognized the 3 recent recipients of the Nobel Prize in Economic Sciences - Drs. Fama, Shiller, and Hansen, and how the media emphasizes the disparities and different perspectives associated with them.

The other two talks were given by my wonderful Finance colleagues, Dr. Bing Liang, who spoke on "Hedge Fund Ownership and Stock Market Efficiency" and Dr. Hossein Kazemi, who gave the last presentation of the day on "Dynamics of Hedge Fund Exposures: Implications for Performance and Herding."

Thanks to my colleagues and to Dr. Andrew Lo for such a fabulous intellectual feast that we all experienced at the CISDM Research Day!

Network Economics of Cyber Crime

I have been working on network economics with interfaces to various applications for quite a while, with the first edition of my book on the topic being published twenty years ago!

About two years ago, we were approached to submit a proposal to the Advanced Cyber Security Center, which was soliciting proposals for its Prime the Pump Initiative and our project, Cybersecurity Risk Analysis and Investment Optimization, was funded.

Our project team is interdisciplinary, and consists of Professors Wayne Burleson of Electrical and Computer Engineering, Mila Getmansky Sherman of Finance, Senay Solak, and yours truly of the Operations & Information Management Department, of the Isenberg School of Management, and Chris Misra, of the OIT Department -- all of us at UMass Amherst.

The Project Synopsis:

The vision of this project was to develop:

• rigorous models for cybersecurity risk,
• models for costs and benefits of various cybersecurity technologies,
• techniques for integrating  these models into higher level models that account for other risks and risk management expenditures.

I will be presenting an aspect of our research project at INFORMS Minneapolis in the presentation entitled: Network Economics of Cyber Crime with Applications to Financial Service Organizations.

 The presentation can be downloaded here.

The invitation to submit a paper to the invited session came from Dr. Alla Kammerdiner, whom I met at a marvelous conference in Yalta, Ukraine.

The session information is here.

Dr. Kammerdiner I wrote about earlier in this blog -- she had run the Boston Marathon that was the site for the terrorist attack last April 15.

Another presentation on our project, from a broader perspective, can be accessed here.

Portfolio optimization, risk management, and operations

As we see every day -- whether in business or in our personal and professional lives -- decision-making and its consequences, are fraught with risk. The risks may take on many forms from political risk to exchange rate risk and price volatility risk to environmental risk and disruption-based risk, as in disasters due to natural causes, accidents, or planned attacks, to name just a few. The world now is reeling from the BP Deep Horizon oil rig blowout, the most graphic, high impact recent environmental and economic disaster.

Risk management, hence, has evolved as a topic in its own right and is necessarily interdisciplinary because of its vital components, be they social, engineering-based, financial, natural, operational, etc.

In terms of business operations, firms may need to decide whether to outsource various economic activities associated with their supply chains or to continue business as usual. They may need to assess whether to merge or to acquire another firm, which may lie thousands of miles away. They may have to identify new partnerships or to shed older ones; to promote and hire new executives, or let others go. Should one build a new manufacturing plant and where? Should one bring to production a new product? Should one expand into new global markets? All such decisions must have embedded within them some measure of risk since we live in uncertain and very dynamic times.

The areas of finance and operations management (propitiously also the name of my department at the Isenberg School of Management at UMass Amherst) can bring much to both research in and the practice of risk management.

Last year I had the honor and pleasure of instructing a course on portfolio optimization in the Executive Education program at Harvard University's Graduate School of Design. The course covered the fundamentals of portfolio optimization and risk management and also discussed the importance of a network and systems perspective to financial management.

My course lecture notes can be accessed here.

Today we are conducting research on global outsourcing and risk management as well as on supply chain network design and risk. Our recent studies on various supply chain network as well as financial network topics can be accessed here.

Without appropriate risk management and risk mitigation strategies our already fragile and vulnerable networks may not be sustainable.

Modern Economic Theory -- where it went wrong and how the crisis is changing it

When I travel there are two things that I never leave home without -- my BOSE headphones and the latest issue of The Economist. Many overseas flights have been more enjoyable and productive because of these two reliable "companions." My next trip, which will not require an airplane, however, will be to Cambridge (Massachusetts) to teach a course in Executive Education at Harvard University. The course is on portfolio optimization, clearly a very timely topic given the financial crisis. My lecture and handouts are prepared and I am ready for an exciting experience. I will be bringing, of course, my latest issue of The Economist (July 18-24, 2009), which is motivating, in part, this posting.

The cover of this issue of The Economist has a brown book with the title, "Modern Economic Theory," that is melting like chocolate in the summer heat. The caption reads: "Where it went wrong -- and how the crisis is changing it." The issue has several articles, which further reinforced the relevance of my my perspective on the material that I will be covering in my course at Harvard.

My view of portfolio optimization is that of a critical building block for general financial models that can capture complex interactions among agents in the economy. Classical portfolio optimization problems also have an elegant network structure that can be exploited both for conceptualization and visualization purposes and also for computation of solutions. Such building blocks can help in the construction of macroeconomic models in which one can then explore all sorts of policies such as taxes, tariffs, price supports, transaction costs, etc., and upon which one can also build international financial network models and even explore financial intermediation. I have been writing a lot on financial networks with intermediation and electronic transactions and have supervised doctoral dissertations on the subject.

Amazingly, in an article, in this issue of The Economist, on page 66, is written "In many macroeconomic models, therefore, insolvencies cannot occur. Financial intermediaries, like banks, often don't exist." Perhaps some of those macroeconomic modelers should read the literature! A great place to start would be the volume: "Innovations in Financial and Economic Networks" that I edited in 2003 and was published by Edward Elgar. Other relevant papers can be found on the Virtual Center for Supernetworks website.

Then, to add further injury, on page 67, and I quote a remark attributed to David Colander, who has been surveying economists: "Instead of solving models 'by hand', using economists' powers of deduction, he proposes simulating economies on the computer." The entire field of Computational Economics is over a decade old and those of use who work in the interfaces of operations research and economics and finance well know the power and the use of not only mathematical models to capture the intricacies of human and economic interactions but also the use of algorithms and computers to predict the results of such interactions, including product and financial flows and prices. We have a Society for Computational Economics, an annual conference (the most recent one just concluded in gorgeous Sydney, Australia), and even a journal!

There is a serious disconnect between the literature and the state-of-the-art and what some economists and policy makers are aware of. It is high time that areas of computational social sciences, including computational economics, get the recognition that they deserve! There is some hope, nevertheless -- on page 69 of the same issue of The Economist, Andrew Lo of MIT is quoted and his novel idea of creating a financial equivalent of the National Transport Safety Board to deal with future financial crises! Coincidentally, and you heard it here first, we will be hosting Professor Lo in our Fall 2009 INFORMS Speaker Series at UMass Amherst (co-sponsored with the Finance series). I can hardly wait!