BofA, MIT Measuring Illiquidity Risk
September 22, 2008
While Bank of America Corp. made a loud splash last week with its agreement to acquire Merrill Lynch & Co., a quieter recent initiative with the Massachusetts Institute of Technology could also have a big impact. Bank of America and the MIT Sloan School of Management's Laboratory for Financial Engineering (LFE) said late last month that they are working together to research computational finance, quantitative analytics and risk-reward tradeoffs.
One goal of the project--part of the Center for Future Banking, created by the bank and MIT's Media Lab in March--is to find a way to measure the risk of illiquidity. "This has been the common thread running through many of the financial crises in recent years and is probably the single most important factor driving current market dislocations," said Andrew Lo, director of LFE and a Sloan professor.
"We've developed a fairly robust set of analytics for measuring illiquidity risk in the hedge fund industry and hope to extend these measures to credit portfolios and other investments using data to be provided by Bank of America," said Lo. The aim, he added, is to better understand illiquidity risk in broader contexts and propose early-warning indicators that might help financial institutions avoid--or at least prepare for--future crises.
"What we've come up with is a single numerical value for liquidity risk," Lo said. The center expects to publish a preliminary paper about the credit crunch and liquidity risk in the coming months. "Consumer credit card and mortgage information data from Bank of America will be in a redacted form to eliminate any personal data," he added.
Bank of America is investing $22 million in the center over the next five years. MIT's Media Lab has a reputation for innovation--among other things, it invented E-ink, used in Amazon's Kindle and the Sony Reader--noted Jeff Carter, Bank of America executive for the Center for Future Banking. Among the center's current focuses is mobile commerce. "What happens when everyone is connected?" said Carter. "How will social networked economies impinge on banking? We know our customers want better control of their financial futures."
"We want to identify connections that aren't so evident in all the vast repositories of data-to make intelligence intelligible," said Abhishek Mehta, strategic adviser at Bank of America responsible the research initiative.
Carter pointed out that Bank of America has a history of working with universities--during the 1950s it developed magnetic ink character recognition, or MICR, technology with Stanford University. "We worked with Stanford on what at the time was an unsolvable problem and came up with check-reading technology."
The challenges now facing the financial industry are at least as daunting. "The million-dollar question is what the investment banking model will end up being after all of this plays out," said Mehta. "It seems apparent that the stand-alone investment banking model will no longer exist."
