Can of Worms

By Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.
www.RSDsolutions.com
info@RSDsolutions.com

The Economist really put one out there two weeks ago.  On its website, the well known British based newspaper had the audacity to ask “Should MBA students care about their professor’s research?”  http://www.economist.com/node/16291542?story_id=16291542

Before I fall into this lake of quicksand a few disclosures are in order.  Although I do research I am not the most prolific referred published academic on the face of the planet.  To be frank, for the field of finance the bar to get into a top journal is so far adrift from the practice of finance that it seems nonsensical to attempt to publish.  (I am sure that will make me popular with the editors of the Journal of Finance.)  Also in the interest of full disclosure you should know that I teach ERM, as well as Derivatives (and a variety of other finance courses) in a variety of business school programs.  Oh, by the way, I also win teaching awards … funny.

In my opinion my field of finance (under which risk management generally falls) suffers from a major case of physics envy.  For a long time B-School professors were thought to be the weak link of the academic food chain.  Research was traditionally based on anecdotal evidence.  That all changed with the construction of financial price databases.  Finance was the field to lead business academics to scientific respectability with quantifiable studies.  Ever since, the academic field of finance has become addicted to quantification to the almost total exclusion of all else. 

My background is actually in physics, and indeed it was the ability to use my physics training that led to my changeover to finance.  However my adopted field has gone way too far – in my opinion.  In finance and risk management we need to realize that not everything can or should be quantified.  Some of the greatest problems do not have numbers attached (or they might have numbers but not enough to get the desired level of statistical significance required for publication.)

The irony of the importance placed on publication is that little if none of the academic literature is, or could be, read by the vast majority of practitioners.  Even the practitioner publications in finance have become too mathematically sophisticated to be read by practitioners, with the exception of the few who might have advanced degrees in math or physics. 

The irony of the Economist article is that even fewer MBA students have any hope of understanding the concepts that are put forth in the top finance journals.  How many MBA students (not specialized Financial Mathematics students) have a background in stochastic calculus, or econometric techniques such as generalized method of moments which are the minimum entrance requirements for understanding current research?

I understand the argument that you do not need to understand the math if the research has useful conclusions.  My counterargument is that the vast majority of top level research has math as the end point and any practical applications are simple a happy accident of the research.  Think I am out of it?  Then send me a note telling me a piece of academic research in the last 5 years that has made a difference in your operations.  (I am sure that there are useful research articles, but unfortunately it takes a long time for them to bubble up and attract attention as they are generally not considered to be sexy enough for the top journals.)

Qualitative risk management and enterprise risk management in particular are relatively new fields of academia.  (Yes, I know that insurance studies, as well as the study of derivatives have been around since business schools have been popular.)  Therefore there might be a hope that risk management does not fall into the trap of worshiping the academic quant gods.