Rethinking finance teaching after the crisis Jayanth R. Varma on what finance can learn from other disciplines From QFINANCE: The Ultimate Resource 4th Edition, Published September 2013, www.qfinance.com Jayanth R. Varma holds a doctorate in management from the Indian Institute of Management, Ahmedabad, where he is now a professor of finance. His latest article is in Bloomsbury's QFINANCE: The Ultimate Resource, out September 2013.
Financial education will be on the UK curriculum from 2014, so perhaps it's time to look at how we teach it. The global financial crisis evoked parallels with the Great Depression of the 1930s, the panic of 1907, the sovereign defaults of the 1890s and 1930s, and the financial (and sovereign) debts of the 1830s and 1870s. From a long historical perspective, it is not the crisis, but the Great Moderation that preceded it in the late 1990s and early 2000s, that seems more like the aberration. Since high-quality data do not usually go back more than a few decades, we do not have the option of fitting econometric models directly to centuries of data. Students should be taught robust models that are qualitatively consistent with decades, if not centuries, of history. Newer, more nuanced models became well established in finance theory in the last couple of decades; the financial crisis has not discredited them, whereas it has showed up problems with older, oversimplified models. The capital asset pricing model (CAPM) was developed half a century ago, but remains the workhorse model in the classroom today. Modern finance theory, on the other hand, has moved on to models where the measure of risk is multidimensional and factors include size, value, momentum and liquidity. VaR models based on past data led to catastrophic underestimates of true risk. Meanwhile, the study of market microstructure has become one of the most exciting fields in finance, and a vast literature of elegant models has emerged. In finance teaching, however, it is only covered in specialized courses, if at all. It was thought that the weird phenomena that take place at the short time scales relevant to market microstructure wash out over longer time periods and become irrelevant for mainstream finance; the global financial crisis has shown this is not so. Quite often, market microstructure has macro-consequences. Insights from psychology in the form of behavioural finance are now an integral part of the standard finance curriculum, but it is necessary to seek inputs from other disciplines as well. Neuroscience tells us a lot about the cognitive capability of the human mind, as well as the nature of risk and time preferences. The sociology of finance asks us to look at markets as complex socio-technical systems that overcome some of the limitations of bounded rationality. Finance students should be exposed to all these important perspectives. For further information, or to contact the author about a longer piece or viewpoint, please do not hesitate to get in touch with Sophia.Blackwell@Bloomsbury.com- Tel: 020 7631 5831 More information at www.qfinance.com About QFINANCE: The Ultimate Resource QFINANCE is a unique collaboration of more than 300 of the world’s leading practitioners and visionaries in finance and financial management, providing an unparalleled range of crossreferenced resources, which are sure to satisfy the hungriest of minds. www.qfinance.com