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The foundation and future of finance

With renewed investment and focus, MIT Sloan asks how global finance faltered and how it can be saved

By Mary Tamer with Zach Church

Excerpts from Robert C. Merton’s notes for course 15.438, Investment Banking. Based on work done at MIT Sloan, Merton and colleagues Myron S. Scholes and Fischer S. Black developed a pioneering formula to determine the value of derivatives.



There has been wound licking and finger pointing, theorizing and sermonizing, but four years after the global financial collapse, there may be only one certainty: nobody—not Wall Street, not the government, not regulators—was ready.

Today, MIT Sloan’s Finance faculty is reexamining what went wrong, what must be done, and how the School’s network of established and future financial leaders can help prevent a reoccurrence.

Robert C. Merton, School of Management Distinguished Professor of Finance

“Finance is truly global; it doesn’t have meaningful borders,” said Nobel Laureate and MIT Sloan Professor Robert C. Merton, PhD ’70. “And, if you look at the financial crisis, one important element that senior management and their regulators really didn’t have was a rich enough, deep enough understanding of their tools.”

MIT Sloan has a tradition of leadership in financial education, but with new faculty, an emphasis on policy analysis, a coming research center, and a new, intensive one year Master of Finance program, its potential impact on the financial sector is significant.

“This is a time of dramatic change,” said David Schmittlein, John C Head III Dean. “And it’s a time when MIT and its broad community appropriately gathers to consider what’s been happening, to consider what needs to happen, and to challenge each other to help create the kinds of futures in this important area of the economy that the world needs.”

In April, faculty, alumni, and current and future students gathered in New York City for MIT Sloan Finance Day, a celebration of the School’s long and accomplished history as a leader in the world of finance, yet as one not willing to rest on its laurels. The Finance Group and its programs have grown and evolved with the field itself, both prior to and in light of the global financial crisis.

“Dave Schmittlein came in and committed to invest in finance and increase faculty,” said Stewart C. Myers, the Robert C. Merton (1970) Professor of Finance. “That started before the crisis. The size of the faculty, the composition of the faculty, and the programs that either are new or expanded happened before the crisis, so at exactly the right time.”

With three goals—innovative curriculum, investment in faculty and a new research center, and outreach to alumni and financial leaders—MIT Sloan is poised to continue its legacy in the science and art of finance into the future.

I. Curriculum Innovation

The way Bob Merton sees it, finance at MIT Sloan has been innovative for decades, right up to the present.

“I’m not alone in thinking that finance and financial engineering has a natural place here at MIT,” said Merton, who returned to the Finance Group in June 2010 after two decades at Harvard. “There was a theme that started 40 years ago that good, leading-edge research has had a profound impact on finance practice... It’s a theme of the Institute and a theme of the Finance Group.”

Andrew W. Lo, Charles E. and Susan T. Harris Professor of Finance

Another theme, it seems, is forward thinking. According to Andrew W. Lo, the Charles E. and Susan T. Harris Professor of Finance and the director of MIT’s Laboratory for Financial Engineering, the Finance Group was the first among the School’s faculty to propose a new curricular concentration within the MBA program, specifically for finance. Beginning in the early 1990s, the School offered concentrations in Financial Management and Financial Engineering for approximately 10 years. In 2008, the two-year Finance track was introduced, and is now chosen by approximately one-third of MBA candidates, all of whom receive a Certificate in Finance upon completion of required and elective courses—as well as extracurricular activities—specifically designed toward career paths in the financial industry.

The same is equally true for those who embark on the one-year, intensive Master of Finance (MFin) program, launched in 2009 to offer the specialized instruction required to train finance professionals in the public and private sectors. Among the most competitive offerings at MIT, the MFin was the first new degree to be approved by the Institute in some time, yielding over 1,400 applicants for the available 124 seats this year. As Lo noted, the program is “remarkable in its popularity and selectivity,” having doubled in size from its previous class of 73 students chosen from 974 applicants.

“MFin was actually something that was raised by the industry,” said Lo, who was named to TIME magazine’s “100 Most Influential People in the World” list in April 2012. “Our philosophy has been to focus on substance, not form; but over the years, we have received enormous feedback on needing more training” for those working in finance.

For Program Director Heidi Pickett, who has worked in the financial services industry for more than 20 years, the MFin program answers that call through the program’s core courses, combined with electives and hands-on, action learning practicums and proseminars. With a focus on imparting both technical skills and training for a successful career in finance, Pickett said what makes the program exceptional “is a strong core with the flexibility to tailor your degree to meet your needs and objectives.”

“When Andrew talked about this program, he said, ‘We need more, not fewer, people highly trained in finance,’” said Merton, who was, in part, drawn back to MIT by the new degree’s creation. “The MFin is designed to give a path in which we take recent graduates, and they go in and have this intensive, 12-month program.... They gain their experience, and their employers get a highly trained staff that has been taught by a very strong group of practitioners and teachers.”

New courses for the MFin program include Merton’s on Retirement Finance, Lifecycle Investing, and Asset Management and Applied Fixed Income Strategies with Saman Majd, SM ’79, PhD ’85, and Eric Rosenfeld, SB ’75, PhD ’80, among others. All students take part in a proseminar or practicum or both, which provide the opportunity to focus on issues of ethics and to build relationships with external partners while addressing a real-world problem faced by a financial firm in New York City or elsewhere.

In addition to economics, finance, and accounting, the MFin program takes advantage of the intellectual ties among finance and mathematics, statistics, operations research, computer science, and engineering.

“We are focusing on a much broader application of skills in finance,” said Lo, “and we see ourselves fulfilling a broader mandate.”

“One of the themes that I saw I could contribute to at MIT is training the people who go forward,” Merton said. “I saw it as fulfilling a very important role of bringing highly trained young people to finance.”

Schmittlein added, “I stand with our Finance faculty in believing that financial systems are going to become more complex, not less complex, whether we like it or not,” said Schmittlein, “and we need leaders in the sector, in government, who understand that complexity and can drive the kinds of policies and practices that this complexity is going to demand.”

II. Evolution and Expansion

It was during Merton’s time as a student in the late 1960s that the MIT Sloan Finance Group was founded, long before many other business schools recognized finance as a distinct field of study. In the ensuing years, and with an influential collection of scholars including Merton, Paul A. Samuelson, Fischer S. Black, John Cox, Franco Modigliani, Stewart C. Myers, and Myron S. Scholes, these pioneers of modern finance received an impressive collection of awards, including several Nobel Prizes for their breakthroughs in financial economics.

“We have the history,” said Schmittlein. “If modern finance was invented in any one place, it was invented at MIT. There comes with that a responsibility that this School’s faculty has taken up to be real leaders.”

Included among the breakthroughs of those leaders are the Black-Scholes/ Merton option-pricing model; the Modigliani-Miller theorems; continuous-time models of consumption and portfolio choice; applications of option-pricing theory to real investments, corporate finance, and other real options; equilibrium models of the term structure of interest rates; binomial option pricing; and the risk-neutral pricing kernel for pricing derivative securities.

Even after 24 years on campus, “I still feel like a houseguest in the house that Samuelson and Merton built,” said Lo. “Bob and his colleagues laid the foundation.

Deborah J. Lucas, Sloan Distinguished Professor of Finance

And, as Lo and Merton both noted, the foundation is continuing to grow, with full-time faculty numbers expanding from 13 to 19 in the last 10 years. New faculty includes Deborah J. Lucas, the Sloan Distinguished Professor of Finance who served as assistant director at the Congressional Budget Office for the past two years in Washington, D.C., creating a group that uses financial analysis to evaluate government policies; and Andrei Kirilenko, currently the chief economist for the Commodity Futures Trading Commission, who will join the Finance Group as a Professor of Practice in January 2013.

“The fact that the group has grown so much mirrors the demand, especially the demand for training,” said Merton. “Research can go on anywhere, but the expansion of the faculty reflects that we need to have the people to implement and execute.”

Antoinette Schoar, Michael M. Koerner (’49) Professor of Entrepreneurial Finance

“We have seen a big change, and it feels like a big change,” said Antoinette Schoar, the Michael M. Koerner (’49) Professor of Entrepreneurial Finance, now in her 11th year at MIT Sloan. “It is very exciting to me that we are still small enough that every person counts. You really engage with everyone, but we are big enough that it is a critical mass of people, so if someone is on sabbatical or overseas, it is still okay. We have much more diversity of topics and interest, and that helps me in my own research. You draw on those stimuli.”

Such levels of collaboration will continue with the spring launch of a planned MIT Center for Finance and Policy, a cross-disciplinary effort to utilize the best that the Institute has to offer in its faculty, programs, and research. With oversight from the Finance Group, as well as an advisory board of MIT faculty and industry leaders, the center will focus on the intersection of public policy and financial theory and practice, bringing “a new level of intellectual substance and rigor to an area previously thought impossible to quantify,” said Lo.

“We have to be informed with the very best analytic thinking, and what’s been missing is nonpartisan analysis,” Lo said. “Each of us has our own political leaning, but we want to put those aside to make the best, most informed judgments. We don’t believe any organization is currently doing this for finance and policy, so we have a unique opportunity.”

Among the center’s pursuits, Lo envisions ongoing analytic research on policy issues; education and training for policymakers and their staffs; and periodic conferences to bring together policymakers, academics, visiting fellows, and a variety of interest groups on neutral ground.

“Aside from sponsoring research that’s relevant to this, one of the missions of the center will be educational,” Lucas said at the Finance Day event in April. “Somebody earlier asked a very good question: ‘If you come up with these great ideas inside of academia, how do you communicate them to the broader world? To policymakers?’ Today there’s a big gap. People talk about the digital divide, but I think there is a financial literacy divide between the government and the private sector. This isn’t only at the top; it permeates down to all staff levels and profoundly affects how decisions are made.”

“Policy is a little bit different because you are not actually telling someone how to make a financial decision; you are saying what the rules of the game for finance ought to be,” said Myers. “This is a mea culpa. We’ve been too passive about policy. We understood the savings and loan crisis before and while it was happening, but we did not go down to Washington and beat the drum. This is another area where MIT Sloan will be much more powerful and prominent moving forward.”

III. Proactive Outreach

In the months of planning leading up to Finance Day in April, faculty from the Finance Group were not sure what they could expect by way of alumni attendance or their depth of engagement. As it turns out, both were overwhelming.

“We had no idea it would be as popular as it was,” said Lo of the sold-out event. “The faculty enjoyed it, the students enjoyed it, and the alumni came out in droves,” with some traveling from the West Coast, Europe, and Asia to attend.

“We were stunned and pleased about the fact that our alumni and former students were interested in engaging with faculty on a really high-level debate about issues ruling finance and the relationship of financial markets,” said Schoar. “People were pleased by the quality of the debate and questions, and we were happy to see how much positive feedback and feelings there are toward the Finance department at MIT Sloan.”

Based on its popularity, which Lo credits to its roster of “star-studded speakers,” the event will likely be held on a biannual basis in New York City. Similar upcoming finance events will take place in London on June 13, 2013, and in Shanghai on July 19, 2013. In addition, other outreach efforts by the Finance Group continue to make an impact both on and off campus, from hosting and participating in a June meeting of the Boston Financial Services Leadership Council to sponsoring a day-long, Institute-wide workshop on finance for MIT faculty to aiding the establishment of the U.S. Treasury Department’s Office of Financial Research (OFR).

On the latter initiative, Merton credits Lo for his role in incorporating the OFR as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. As an independent, nonregulatory institution for finance, the role of the OFR is to improve the quality and analysis of data for policy and decision makers to “produce, promote, and sponsor financial research aimed at developing the analytical tools we need to assess threats to financial stability,” according to the U.S. Department of the Treasury website.

Back on campus, a June course titled, Finance Made Difficult, drew nearly 75 faculty members representing departments across the campus, all of whom signed on for an opportunity to gain insight into the workings of the Finance Group.

“We had the chance to teach a bunch of great students, and we were able to acquaint people at the Institute with what we do,” said Merton, who noted that Lo taught the participants the basics of finance. “Even if they didn’t get the lyrics, they got the tune.”

As yet another means of outreach to alumni as well as financial industry and academic partners, the Finance Group has its own 32-member advisory board, charged with offering advice and guidance on all department initiatives.

“We engage them when possible with our students,” said Pickett, “in networking, receiving feedback on their pitches, and through other career-advising opportunities.”

“All of the efforts of the Finance Group,” said Merton, “fit very well in the Institute’s tradition of cutting-edge research and bringing it to bear to solve problems. We see the challenges out there, and they suggest great opportunities.”

“Not only do we know that finance is important, but politicians and the media and the public know that finance is important,” said Myers. “We need to make it effective and efficient and fair.”