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A series of econometric methods and software, designed by a team of econometricians at Oxford, have been adopted as standard by a large range of governmental bodies, international agencies and businesses. The econometric methods are designed to model and forecast high-dimensional, evolving economic processes facing multiple structural shifts, while the econometric software (PcGive) implements the resulting best-practice procedures. The application of these methods have resulted in more appropriate empirical models, improved robust forecasts, and, consequently, better decision making by these bodies.
Research undertaken at the University of Manchester (UoM) has contributed to the development of a new interdisciplinary field, `Mathematical Behavioural Finance' (MBF), that deals with mathematical models of financial markets based on behavioural principles. These models go far beyond the conventional paradigm of fully rational utility maximization, and reflect a whole variety of patterns of market behaviour. A particular emphasis is on evolutionary aspects: growth, domination or just survival, especially in crisis environments.
Impacts can be seen in investment strategies based on MBF that have been successfully employed in large scale funds, since 2008, by Swiss and German corporate investors (AllMountain Capital AG and Deutsche Bank). These strategies have demonstrated high rates of return combined with relatively low volatility, coping exceptionally well with one of the most severe financial crises in recent history.
This case study charts the influence of the Risk On / Risk Off (RORO) paradigm, developed in research at the University of Oxford in collaboration with investment bank HSBC. Since 2008, RORO has had a significant economic impact on HSBC as well as wider impact on the thinking and actions of investors and other global market participants. Having begun as a specialised research tool within HSBC's foreign exchange team, the RORO methodology was publicised in the advice that HSBC supply to a wide range of major fund managers, corporate institutions and central banks. The research has led directly to a change in the way that asset managers think about investment decisions, with consequent impact on the investment and risk management strategies they undertake. RORO is regularly featured in the financial press and is becoming increasingly mainstream, with coverage in national and international media aimed at retail investors.
General insurers are required to have a capital reserve to cover outstanding liabilities, i.e. liabilities that have been incurred but not settled, or perhaps not even reported. Under the new Solvency II regulation, adopted by the EU Council in 2009, general insurers now face complex new capital requirements. These new regulations must be fully implemented by 2016. The development of new statistical methods led by Dr Bent Nielsen and his co-researchers, in collaboration with the general insurer RSA, extends traditional forecasting methods, and provides tools by which insurers are able to meet these new statutory requirements.
Our research team has developed new approaches to classifying demand series as `intermittent' and `lumpy', and devised new variants of the standard Croston's method for intermittent demand forecasting, which improve forecast accuracy and stock performance. These approaches have impacted the forecasting software of Syncron and Manugistics, through the team's consultancy advice and knowledge transfer. Subsequently, this impact has extended to Syncron International and JDA Software, which took over Manugistics. These companies' forecasting software packages have a combined client base turnover of over £200 billion per annum, and their clients benefit from substantial inventory savings from the new approaches adopted.
As part of our commitment to public sociology (see REF3a), we have prioritised making Edinburgh sociological research on financial crises available to wider audiences: financial practitioners, policy makers and interested members of the general public. This has been primarily via six essays by Donald MacKenzie in the London Review of Books (LRB) and two invited articles in the Financial Times, listed in section 5.3. The impact of this research is in enhancing cultural understanding of finance and contributing to critical public debate. Evidence of its significance and reach includes: (a) public recognition (eg Prospect magazine naming MacKenzie amongst the 25 intellectuals with most impact on the "public conversation" about the financial crisis); (b) articles by others in prominent sources (the Financial Times and Economist) drawing on his work; (c) use of the Edinburgh University research in a major US corporate lawsuit; (d) reprints of the LRB articles eg in French and German public affairs magazines, in the booklets accompanying a Swedish exhibition and a Belgian art video, and in two financial-practitioner magazines.
Professor David Leece's research on household decision making, risk and mortgage design had a significant influence on a fundamental review of the United Kingdom's mortgage market carried out in 2003-4, and consequently has had a major continuing impact on: (i) understanding the role of mortgage market economics in the financial crisis of 2007-8; and (ii) the ability of a global investment bank (and the banking sector more widely) to understand, value and hedge risk in securitised mortgage debt.
Research of Professor Brigo in the areas of credit risk, pricing models for the valuation of counterparty risk, and the development of accurate calibration methods of various credit risk models has generated significant impact both on public policy and on practitioners and professional services. His models were implemented and his calibration methods adopted in the financial industry. The significance attached to his work by the industry also resulted in a collaboration with the German regulator (BAFIN). Further evidence of his impact can be found in the fact that a Court of Law based its analysis in a financial intermediation case on Brigo's research.
Prof. Pennanen and collaborators have developed mathematical models and computational techniques for financial risk management. The techniques allow for quantitative analysis and optimization of financial risk management actions in an uncertain investment environment. The techniques have been used by the State Pension Fund, Ministry of Social Affairs and Health, Bank of Finland and Pension Policy Institute. The techniques have significant impact on practitioners and professional services in increasing the awareness and understanding of long-term financial risks that are difficult to quantify with more traditional techniques. Beneficiaries of the developed risk management techniques include future pensioners and tax payers.
The largest investment banks in London each have thousands of servers largely devoted to Monte Carlo simulations, and to quantify their risks and satisfy regulatory demands they need to be able to calculate huge numbers of sensitivities (defined below) known collectively as "Greeks". An adjoint technique developed by Professor Mike Giles in 2006 greatly reduced the computational complexity of these calculations. The technique is used extensively by Credit Suisse and other major banks, reducing their computing costs and energy consumption. It has also led to the Numerical Algorithms Group developing new software to support the banks in exploiting this new adjoint approach to computing sensitivities.