New Frontiers in Finance

What's ahead for Vanderbilt's high-profile finance meeting of the minds.

From the Fall 2014 edition of Vanderbilt Business

By Ryan Underwood | Features, Homepage Highlights

FMRC meeting — Robert Whaley, the Valere Blair Potter Professor of Management (standing), looks to expand the conference’s role as a forum for the world’s top financial experts to explore and discuss significant financial topics.

When Hans R. Stoll, the Anne Marie and Thomas B. Walker Jr. Professor of Finance, launched the Financial Markets Research Center’s first annual conference in the spring of 1988, he did so in the spirit of wanting to more fully understand the previous year’s sudden stock market crash. Bringing leading academic figures, top government regulators and industry executives to Vanderbilt University for that first conference, Stoll began a rich tradition of assembling thought leaders to explore some of the most pressing topics in finance.

It’s a tradition that Robert Whaley, the Valere Blair Potter Professor of Management, hopes to strengthen and grow as sole director of the FMRC.

“We have the opportunity to play an even larger role in the world of finance,” says Whaley, a renowned scholar and creator of the closely watched Market Volatility Index (VIX) who previously served as co-director of the FMRC alongside Stoll.

“In addition to the top-tier research and expertise from our own faculty, we are able to attract leading thinkers from around the world—from industry, from major regulatory agencies, and from top academic institutions—to discuss the most important topics facing today’s financial markets.”

Internationally known speakers

Over the years, Vanderbilt’s annual FMRC conference has hosted speakers such as former Fed Chairmen Paul Volcker and Alan Greenspan; Nobel Memorial Prize winners Eugene Fama, Robert Merton, Merton Miller, Robert Shiller and Myron Scholes; and industry leaders like Leo Melamed, chairman emeritus of CME Group; William Brodsky, longtime chairman and CEO of the Chicago Board Options Exchange; and Thomas Peterffy, founder of Interactive Brokers.

The conference attracts leading thinkers from around the world to discuss the most important topics regarding financial markets.

Participants have been drawn to the event by the school’s distinguished finance faculty. In addition to Stoll and Whaley, Owen Graduate School of Management professors include Bill Christie, whose paper on NASDAQ broker collusion led to a significant regulatory overhaul; Craig Lewis, who most recently served as chief economist of the SEC; and Nicolas Bollen, one of the world’s foremost experts on hedge funds.

Additionally, Dewey Daane, the Frank K. Houston Professor of Finance, Emeritus, who served as a Federal Reserve Board governor from 1963 to 1974, continues to attract many distinguished guest speakers to campus. Most recently, he helped bring Edward J. DeMarco, who ran the federal agency overseeing Fannie Mae and Freddie Mac, to Vanderbilt. In addition to serving as a visiting professor, DeMarco was a 2012 FMRC keynote speaker.

Compelling topics ahead

Whaley says he is already mapping out topics for future FMRC conferences. In October, finance professor Nicholas Crain hosted a conference on private equity which included a keynote by Bruce Evans, a member of Vanderbilt’s Board of Trust and managing director of Summit Partners in Boston. And for the 2015 FMRC spring conference, Whaley is starting to assemble a group to discuss the role that options and other derivatives have played in reshaping markets. “We’re intent on bringing the very best people we can find to the conferences we host,” Whaley says.

Modern finance legends attend the spring 2014 FMRC — Three of modern finance’s legends—colleagues with Hans Stoll at the University of Chicago during the 1960s—joined him at the May conference. From left, Eugene Fama, Myron Scholes, Stoll and Richard Roll. Fama and Scholes both received the Nobel Memorial Prize in Economic Studies.

What They Said

Academic discussions from the 2014 conference

The 2014 FMRC conference—held on campus this past May—explored some of the new research frontiers being discussed in academic finance. Several of the luminaries who worked alongside Stoll at the University of Chicago in the 1960s (the dawn of modern finance) presented their latest work at the 2014 FMRC gathering. Here’s a synopsis of what was presented.

Many Financial Research “Discoveries” Are Probably Wrong
Campbell R. Harvey, Fuqua School of Business, Duke University
In scientific fields like medicine and astrophysics, researchers often have to pass a high statistical bar for a new finding to be considered statistically significant. However, the standard benchmark is far lower in most finance and economics research, calling into question many of what are considered novel discoveries. Harvey, who served as editor of the prestigious Journal of Finance from 2006-12, argued in the paper he presented that, “It is a serious mistake to use the usual statistical significance cutoffs” that have been applied to many current asset pricing models.

Short-Selling Constraints Limit Correction of Overpriced Assets
Robert F. Stambaugh, Wharton School, University of Pennsylvania
Recent studies in academic finance have begun to find an unexpectedly negative relationship between expected asset returns and risk that does not stem from the market, known as idiosyncratic volatility. In his FMRC presentation, Stambaugh argued that short-selling constraints are driving this volatility puzzle. Where investors tend to correct for underpriced assets by taking a long position, the same does not hold true for overpriced assets, which require taking a short position, something done mostly by sophisticated traders.

High-Frequency Activity Doesn’t Increase Quote Volatility, Just Changes It
Joel Hasbrouck, Stern School of Business, New York University
Lost in the noise of discussion about high frequency trading is the role that rapid price quotes—not just executions—play in the markets. In his FMRC presentation, Hasbrouck said the average volatility of price quotes has not changed much in the period from 2001 to 2011. What has changed is the nature of quote volatility. Prior to the advent of electronic trading, price quotes tended to experience more fluctuation but at less frequent intervals; today the opposite is true, with more frequent oscillations, but less extreme price variations. The overall level of volatility among high-frequency quotes, however, remains about the same.

The Search for Meaning in Contingent Claims Trading Activity
Richard Roll, Anderson School of Management, UCLA
Financial economists have made significant progress in pricing derivatives tied to assets such as the cash S&P 500 index. However, much less work has been done on what differing trade volumes in contingent claims (options, legacy and E-mini futures contracts, and ETFs) may mean. For example, can trading activity in some contingent claims forecast macroeconomic conditions better than others? Roll presented empirical data at the FMRC conference that’s being used to explore these types of questions. Among the early findings: Some evidence that options volume predicts absolute returns around major macroeconomic announcements.

Liquidity Constraints Lead Sophisticated Investors to Overprice Securities
Myron Scholes, Graduate School of Business, Stanford University
Contrary to popular belief, irrational noise traders or other potential hidden risk factors are not responsible for mispricing high-volatility stocks, Scholes said in his presentation. Instead, it may be that professional investors are driving up the price of volatility stocks because of the tracking-error and liquidity constraints they face. The result is that safer, low-volatility stocks tend to far outperform high-volatility stocks, not just in times of crisis, but over the long term as well, contrary to expectations.

Augmenting the Fama-French Three-Factor Model
Eugene Fama, Booth School of Business, University of Chicago
The traditional Fama-French three-factor empirical asset-pricing model has been shown to explain returns with a significant degree of confidence based on dimensions of market, size, and book-to-market factors. However, Fama says that two other factors should be added: expected profitability and expected investment. This new Fama-French five-factor model explains between 69 percent and 93 percent of the cross-section variation in expected returns for the portfolios examined in the paper Fama presented at this year’s conference.