Risky Business: does financial engineering add up?

Sunday 1 November, 9.45am until 10.30am, Lecture Theatre 1 Breakfast Banter

We are living through the most severe recession since the 1930s, a recession that is understood by many as having its roots in the activity of financial services.
It is still unclear how the fall out of the credit crunch will affect financial activity in the years to come. George Soros, echoing the views of Warren Buffett, has famously described Credit Default Swaps as financial weapons of mass destruction. The world’s governments are looking to regulate derivative trading, which is deemed too risky to be left to merely the self-interest of shareholders to monitor.

While blaming the banks for taking on too much risk, it is easy to forget that over recent decades the role of the world’s financial centres has increasingly involved the better management of risk. The length and stability of the global economic boom ending in the credit crunch was in no small part attributed to the ability of these financial centres to help businesses generate higher returns for lower levels of risk. Those days are gone.

Financial products are designed to transfer risk from businesses to the financial sector, or to reallocate risk more efficiently within the market. So a financial intermediary – for a fee – will assume or pass on to others the risks of the volatile oil markets, leaving airlines to concentrate on flying goods and passengers around the world. Has this type of activity now been discredited altogether? Have the legitimate business drivers behind financial activity been swamped by financial activity with no purpose? As Gao Xiqing, an adviser to the Chinese premier, remarked in 2000, ‘if you look at every one of these [derivative] products, they make sense. But in aggregate, they are bullshit’. Were we merely too ambitious in the pretence that financial engineers could not only hedge away the risk of volatile commodities markets, but also hedge away the systemic risk of a global slowdown?

Dr Paul Wilmott
researcher and educator, finance and risk management; author, editor and consultant, quantitative finance and mathematics; founding partner, Caissa Capital hedge fund; founder, Applied Mathematical Finance

Stuart Simpson
financial services professional; researcher and writer, emerging economies and quantitative finance

Produced by
Stuart Simpson financial services professional; researcher and writer, emerging economies and quantitative finance
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