Author Archives: MIT Sloan Finance Group

In Shanghai, charting the future of global finance

Third MIT Sloan finance forum examines interconnected finance systems and China’s role in the world economy

Professor Robert Merton

More than 200 finance professionals and MIT Sloan alumni gathered in Shanghai this month for a day of discussion on the future of modern finance, the third in a series of forums that bring MIT Sloan faculty around the world for frank discussions about finance and policy.

“[MIT Sloan] has the responsibility to lead and develop what the world needs for finance,” dean David Schmittlein told the audience at the July 19 event. “It’s important for us to develop the concepts and methods that will allow us to develop the complex, sophisticated financial systems that the world needs, with a resilience that the world also needs.”

“The world needs more smart people who understand complex financial systems,” he said. “Not less.” MIT Sloan this year launched the MIT Sloan Center for Finance and Policy.

Sound modern financial systems are built using expert knowledge to interpret vast amounts of data. To contribute to the discussion, MIT Sloan professors Deborah Lucas, Robert Merton, Jun Pan, and Stephen Ross shared their latest research on financial models and systems that address some of the challenges in modern finance.

And MIT Sloan alumni covered a range of topics in two panels. On one, two of China’s top financial professionals discussed the role of finance in emerging markets, while another group discussed ways to lead the financial organizations of the future.

Finance is becoming increasingly important for emerging markets

Shanghai, China’s financial capital and aspiring world financial center, was an apt location to discuss the role of finance in the growth of emerging markets. Leaders in emerging markets are seeking to better manage growth, gathering more knowledge and talent from the financial field than ever before.

“The era when very few Chinese financial professionals were up to date with the latest academic research findings is over,” said Haizhou Huang, managing director and head of the sales and trading department of China International Capital Corporation. There is an “ever-increasing number of Chinese financiers being educated at leading institutions like MIT Sloan,” he said.

Emerging markets are also challenging the post-2008 financial crisis system. Huang pointed out the benefit of China’s lack of heritage in finance, suggesting it gives China “an opportunity to create finance for the future, with a completely new financial system.”

Interconnectedness in finance can be a strength

Increased interconnectivity of global financial markets, a phenomenon of the modern financial system that was widely commented on during the crisis, was a key theme throughout the forum.

Professor Robert Merton, a Nobel laureate, introduced a new approach for analyzing and managing macro financial risks by leveraging the many connections between financial bodies that makes the world of finance so complex.

Merton’s goal is to “figure out ways to convey information with vast connections and numbers in a fashion that’s useful in trying to understand what’s going on.” He believes his approach will help guide finance professionals toward asking prescient questions when examining global markets.

Rather than view the complicated interconnectedness of financial systems as problematic, Merton was optimistic.

“The mere observation of growing connectedness is not in itself a suggestion of contagion or systemic risks. It may even be a reflection of the improvements in the global system,” he said.

MIT Sloan has also held finance forums in New York City and London.

Unlocking the modern financial system

Leading MIT Sloan finance faculty share research, ideas with alumni in London

Professor Robert Merton speaks at the MIT Sloan Finance Forum: Financial System 2.0

The financial system is evolving and businesses and regulators need to move quickly to keep pace with the speed of change. That was a key lesson at Financial System 2.0, a special event held in London on June 13 as part of the MIT Sloan Finance Forum series.

Some 200 alumni and friends of the School attended the event, which saw MIT Sloan’s leading academics meet with experts from across the finance industry to discuss the state of the world’s financial markets and how to shape what comes next.

Highlights of the day included:

Professor Stewart Myers look at management incentives and corporate governance. Myers discussed ways to build a functional balance between shareholder remuneration and good company management, including the idea of levying a transaction cost on shareholder intervention.

Professor Andrew Lo’s examination of how financial markets can be harnessed to help cure cancer. Lo explained that a typical cancer drug development program could cost  $200 million, with a success rate of 5 percent. However, instead of investing in one program, it might be possible to invest in 150 different ones, with diversification offering investors more than a 99 percent chance of at least two successes and a higher return on investment. The reduced level of risk resulting from diversification would allow managers of a “cancer megafund” to issue approximately $16.7 billion of debt immediately, Lo said.

“Instead of declaring war on cancer, we should put a price on its head,” said Lo.

A frank discussion, chaired by Financial Times commentator Gillian Tett, on hedge funds and how they are evolving to respond to the shifting financial landscape.

An overview of MIT Sloan’s intensive, one-year Master of Finance program. Launched in 2008, during the financial crisis, the program was developed to put highly-trained graduates to work in the financial sector. MIT Sloan’s goal is to create the next generation of global finance leaders, with a deep understanding of the profession’s potential contributions to society. Graduation data demonstrates that it is succeeding: although the finance sector has seen a general decline in interest, the number of graduates from MIT Sloan’s Master of Finance program continues to grow.

Professor Antoinette Schoar’s demonstration of how to apply insights from behavioral finance in order to mitigate credit risk, particularly in emerging markets. Schoar explained that in many emerging market countries, small businesses regularly pay late and go into default. Behavioral economics suggests small businesses and individuals in emerging economies slip into default through lack of attention to the repayment cycle, said Schoar.

Professor Andrei Kirilenko’s discussion of market evolutions and high-frequency trading. Kirilenko asked whether high-frequency trading is essentially beneficial or “legalized front­running.” He showed that a survey of market participants concluded that high frequency trading had been the cause of the May 2010 “Flash Crash” that saw the Dow Jones Industrial Average dip 9 percent only to rebound a few minutes later.

But Kirilenko shared research showing that high-frequency trading had not caused the crash.

“We should not look at high-frequency trading as being ‘good’ or ‘evil,’” Kirilenko said. “It is more productive to think of it as a trade-off between beneficial and detrimental effects.”

Kirilenko also discussed the new MIT Sloan Center for Finance and Policy, which will serve as a hub for financial analysis of public policy issues and a collaborative platform to stimulate cooperation between government, the private sector, and academia.

Professor Robert Merton’s demonstration of the role connectedness plays in the global financial markets. Merton warned that there is a need to improve integration between the different parts of government with responsibility for managing fiscal policy and promoting stability.


View videos from this event here

MIT Sloan, friends celebrate life of Nobel laureate Franco Modigliani


Stewart Myers, Robert Merton, and James Poterba

The late Franco Modigliani, who won the 1985 Nobel Memorial Prize in Economic Sciences, was celebrated April 9 for his many contributions to the field of economics and his lasting legacy at MIT, where he taught for more than four decades.

Fellow economists, former students, Boston-area professionals, and family gathered at the MIT Faculty Club for the two-hour long “A Celebration in Honor of Franco Modigliani” to delve into the academic giant’s work in economics and finance and to share stories about the man whose infectious enthusiasm affected so many.

“It’s very hard to believe Franco passed away almost a decade ago,” said Stewart C. Myers, professor of finance at MIT Sloan. “I remember him so vividly I can expect him to walk through that door. And if he did, I think he’d have the same combination of energy and happiness about the field of economics, ideas about economics, and absent-minded generosity he was famous for.”

Modigliani won the Nobel Prize for his pioneering analysis of savings and financial markets. He taught at MIT from 1962 until his death in 2003. Nobel laureate and MIT Sloan professor Robert Merton said Modigliani’s work remains relevant.

“There’s no question his work has a long shelf life,” said Merton. “In 2013, it’s still cutting edge.”

A lasting impact on economic foundations

Franco Modigliani

Merton, speaking on the panel “The Life and Times of Franco Modigliani,” said that before Modigliani’s Life Cycle theory, economists tried to explain how people save and consume by looking at a single year in a person’s life.

Modigliani’s insight was that people plan their consumption and savings over a lifetime in order to spend in retirement.

“He believed most people believe a standard of living in work or retirement should be similar—they don’t want to live on dog food and dine on crystal in retirement, or the reverse,” Merton said.

Modigliani’s work led to the commonly used income-replacement ratio. It remains relevant in today’s MIT Sloan classrooms.

MIT economics professor James Poterba compared Modigliani to Isaac Newton—someone whose work formed the building blocks studied in today’s classrooms.

“Franco’s work is timeless,” Poterba said. “The issues he worked on are the big questions. They are as important today as when he wrote his papers.”

Poterba said Modigliani’s work on monetary theory and stabilization in 1944 “clarified for the rest of the world…sometimes you couldn’t influence the macro economy any more by pushing on interest rates.”

Modigliani also built, along with economist Albert Ando, a large-scale model of the U.S. economy to test the impact of monetary policy.

“We learned enormous amounts about individual sectors of the economy,” Poterba said. “No part of the economy was safe from Franco’s microscope. It was tremendously influential.”

Modigliani was also a pioneer in behavioral economics, currently a hot field of study. In the early 1980s he believed the stock market was underpriced because people weren’t choosing to account for high inflation. As a result, he cautioned investors to hold stocks for a long time so their value could rebound.

Myers said Modigliani left his fingerprints on the way corporate finance is studied and practiced. In 1958, he and economist Merton Miller devised the Modigliani-Miller theorem, which says a corporation’s value is unaffected by whether it is financed by debt or equity.

“It moved corporate finance from the Dark Ages to the Renaissance,” Myers said.

Today, bank regulators want lenders to have greater debt to equity ratios. Bankers oppose this, saying that would hurt their corporations. Myers believes Modigliani would conclude that’s wrong—the theorem says the amount of debt and equity shouldn’t affect the value of a corporation.

“Modigliani would say that’s a freshman-level mistake,” Myers said. “Informed corporate finance always starts with Modigliani-Miller.”

Fervent inquiry into pressing problems

Born in Italy in 1918, Modigliani was always interested in Italian and European economics, long after he and his wife, Serena Calabi, immigrated to the United States in 1939.

A second panel, “The Fate of the Euro,” considered how Modigliani would react to the financial crisis affecting Europe and Italy today.

Panelist Francesco Giavazzi, a professor of economics at Bocconi University in Milan and a regular visiting professor at MIT, noted that in 1998 Modigliani predicted a crisis if wages and labor costs fell out of line.

“You see Franco was right,” Giavazzi said. “Prices did go out of line and the issue today is how to bring these prices back in line with each other.”

Modigliani’s granddaughter, Leah Modigliani, said her grandfather would have liked an opportunity to fix today’s euro crisis. In fact, he never stopped trying to solve the world’s economic problems. She remembered a trip to the beach with a childhood friend that was cut short when her grandfather suddenly had an idea to save Social Security.

“My friend asked, ‘What is your grandfather talking about?’ Well, he has an idea to save the U.S. Social Security system,” Modigliani recalled. “And he would in fact write a letter to The New York Times, and by the time I got home he’d have gotten (Federal Reserve Chairman Alan) Greenspan on the phone to discuss his ideas.”

“He said these things about trying to make the world a better place,” Modigliani added. “His ideas were contagious.”

Beyond his lasting imprint on the study of economics, Modigliani left an impression on many people around MIT.

Serenella Sferza, co-director of the MIT-Italy program, said Modigliani was among the faculty who advised her on establishing the program, which now sends 50 students to Italy annually. Like other panelists, she said she learned that all doors in Italy opened to Modigliani.

But as an MIT student, Sferza studied political science and not economics.

“I envied fellow Italians doing their PhD in economics,” Sferza said. “They had better fellowships, shorter dissertations, and they had Franco Modigliani, who was a magnate, full of authority, good humor, and generosity.”

The Celebration in Honor of Franco Modigliani was held as part of the 2013 Year of Italian Culture in the United States, and Pioneer Investments’ U.S. Colloquia Series.