Note from the Director
When we sent out the first CAFIN newsletter a year ago, I had visions of producing it several times a year. Given we live in an age of information overload, perhaps it is best that we are settling into an annual report. The past year has been extremely productive for us, including events, research projects, collaborations and an important new educational initiative. We have added six Research Affiliates, and continued to receive strong support from several UCSC alumni. Our new affiliates are Bradley Jones (IMF and U. of Cambridge Judge Business School), Jamus Lim (Abu Dhabi Investment Authority), Susan Thomas (Indira Gandhi Institute of Development Research), Chenyue Hu, Kristian López Vargas and Kai Pommerenke (all UCSC). Please join me in welcoming them here.
The rest of the newsletter provides a taste of CAFIN’s activities and accomplishments over the year, but I want to first thank some of our friends – all UCSC alumni. Stephen Bruce (Cowell, ’79) was our earliest supporter, and continues to help us. Mike Cagney (Porter, ’93), MS, ’94) is providing CAFIN and the Economics Department with a Bloomberg license, which has proved critical for many of our students and faculty, by giving them access to key financial data for their research. Larry Rowen (Stevenson, ’82) and his team designed a striking new CAFIN brochure, the cover of which can be seen above. The brochure can be downloaded here. Special thanks go to James Hutchinson (Stevenson, ’79), who has intellectually engaged with us on a regular basis, besides supporting us generously. Jim’s statement about CAFIN follows.
UC Santa Cruz’s new Center for Analytical Finance (CAFIN) represents, for me, an effort that is in the best traditions of the campus. CAFIN brings together faculty from different fields, including economics, applied mathematics, and statistics, to tackle how the financial sector works—from how markets should be designed, to who gets to access them, to the risks that can build up in the system and threaten the real economy. CAFIN also reaches out to other academics in fields such as sociology and law, and to practitioners and policy makers. CAFIN not only seeks deep understanding of the finance-related issues that represent a challenge for the modern economy, but it also points the way to practical solutions. Beyond that, CAFIN is launching new efforts to educate the next generation of practitioners of various aspects of finance, as well as imparting basic financial knowledge to students at large. As a proud alumnus of UC Santa Cruz, I have been happy to be a supporter of CAFIN from its earliest days, and urge you to join me.
– James K. Hutchinson (Stevenson, ‘79)
In March 2016, the Science and Justice Research Center invited CAFIN to collaborate on a panel examining social and ethical problems at the intersection of technology and finance. Panelists included alumna Sherry Paul (Cowell, ’91), now a Wall Street wealth adviser, and Distinguished Professor Daniel Friedman, a CAFIN steering committee member. A full report by Melissa De Witte can be found here. Special thanks are due to Professor Jenny Reardon, Director of the SJRC, for initiating the collaboration.
The following month, as part of CAFIN’s quarterly lecture series, Professor Raquel Prado of Applied Mathematics and Statistics, also a CAFIN steering committee member, hosted Professor Mike West, Arts and Sciences Professor of Statistics and Decision Sciences, Duke University, speaking on "Bayesian Predictive Synthesis."
The talk revisited a theoretical framework for model and forecast uncertainty assessment that links back to 1980s/90s literatures that cut across statistics, economics, management science and other fields. Using Bayesian methods, Professor West developed a coherent theoretical basis for combining multiple forecasts, and illustrated the methodology with an example of forecasting inflation – a major concern of central banks around the world.
Another quarterly lecture, hosted by CAFIN steering committee member Eric Aldrich of Economics in October 2016, featured two of his coauthors, Professors Joseph Grundfest of Stanford and Gregory Laughlin of Yale. The interactive talk, titled “When Milliseconds Matter: Rethinking Data Analysis in Markets Dominated by High Frequency Trading,” examined the causes of events such as the Flash Crash of May 2010, when stock markets plunged inexplicably. The work of this trio has featured prominently in news reports discussing the causes of the market plunge, including the possible role of a solitary trader. This work is available as a CAFIN Working Paper, and can be found here.
Finally, in November, CAFIN Research Affiliate and Naval Postgraduate School faculty member Amilcar Menichini joined the CAFIN Director to co-organize a workshop on “Advances in Firm Valuation.” The research presented at the workshop provided new insights into how firms conduct risk management, what kinds of anomalies exist and persist in stock price returns, and how news and information feed into financial market behavior. Ultimately, these findings have implications for how practitioners within firms and in financial markets should make their capital budgeting and portfolio allocation decisions. A full report can be read here.
CAFIN has provided research support for several projects over the past year (many of the results can be found here). Examples of CAFIN-funded research include “Do Credit Rating Agencies Provide Valuable Information in Market Evaluation of Sovereign Default Risk?” by UCSC Ph.D. alumnus Mahir Binici of the European Central Bank and Distinguished Professor of Economics and CAFIN steering committee member Michael Hutchison (photo); “A Dynamic Model of Firm Valuation,” by Amilcar Menichini and UCSC faculty member and CAFIN Research Affiliate Natalia Lazzati; “Relative Spread and Price Discovery,” by Eric Aldrich and UCSC Ph.D. alumnus Seung Lee; and “Bayesian Stochastic Volatility Models for High-Frequency Data,” by Georgi Dinolov, Abel Rodriguez, and Hongyun Wang, respectively, a doctoral candidate and faculty members of the Department of Applied Mathematics and Statistics. Professor Rodriguez also serves as a CAFIN steering committee member.
CAFIN’s most ambitious research project has been on financial market design, tackling problems highlighted in Michael Lewis’ bestselling book, Flash Boys. Professors Aldrich, Friedman and López Vargas are working with several other researchers, including CAFIN Research Affiliate Professor Peter Cramton of the University of Maryland, to study the performance of competing market formats in the presence of high frequency trading (HFT), computerized trading strategies that seek profit via faster execution of orders, on the order of a thousandth (or even a millionth) of a second. This project is developing a flexible financial exchange that can host different market formats and simulate normal or stressful market conditions. It will be a platform for conducting laboratory experiments and public tournaments. With CAFIN seed funding, the project has attracted favorable attention from officials in regulatory agencies (including the SEC and CFTC), major exchanges (including NASDAQ and EBS), trade groups (including HMA) and central banks (including Bundesbank). Preliminary results suggest that a proposed new market format may indeed reduce high frequency trading while improving liquidity and efficiency. Initial results have been obtained at UCSC’s pioneering experimental economics lab, LEEPS, founded by Professor Friedman.
CAFIN is collaborating with the UCSC Department of Economics to launch a program in Spring 2017 that will support UCSC undergraduate and Master’s students in qualifying as “Charterholders” of the Chartered Financial Analyst (CFA) Institute. The non-profit CFA Institute oversees worldwide admittance into its University Recognition Program, leading to the CFA professional credential or “Charter.” UC Santa Cruz is the only UC currently to achieve this recognition. The program will include a professional development seminar and guest speakers from the financial services industry.
The Spring 2017 seminar will be led by CAFIN Research Affiliate Kai Pommerenke, a UCSC Ph.D. alumnus, finance lecturer and CFA Charterholder. It will cover topics relevant to the CFA examination. The seminar will also feature guest lectures by finance professionals on a range of topics, including, importantly, practical ethical issues. Other potential areas include financial reporting and analysis, security analysis, portfolio management, and corporate finance. This program will provide an important new avenue for students to obtain marketable skills for a challenging job environment. Many students from low-income backgrounds lack access to networks when seeking their first job, and the CFA qualification program will be especially valuable for them. This will be the only CFA preparation offering in the entire UC system.
- Terrance Odean, Rudd Family Foundation Professor of Finance at the Haas School of Business, UC Berkeley, and CAFIN Research Affiliate, received the 2016 James Vertin Award from the CFA Institute, for producing “a body of research notable for its relevance and enduring value to investment professionals.” More on the award is available here.
- Maria DeYoreo, former Ph.D. student of CAFIN steering committee member Professor Athanasios Kottas, won the 2016 Savage Award for the best Ph.D. thesis in Applied Bayesian Methodology.
- Professor Raquel Prado gave one of four keynote plenary lectures at the 2016 World Meeting of the International Society for Bayesian Analysis.
- CAFIN Research Affiliate and Economics faculty member Grace Gu has a new research paper on “The Pricing of Sovereign Risk Under Costly Information,” which will appear as a CAFIN Working Paper.
- Professor Yin-Wong Cheung of City University of Hong Kong is organizing a conference on high frequency trading and financial market design, in which CAFIN will collaborate.
CAFIN wishes to acknowledge the continued support of Prof. Sheldon Kamieniecki, Dean of Social Sciences at UCSC.