Friday, November 12, 2010

A Columbia Financial Mathematics prof, Steven Kou seeks to examine the social causes of the economic crisis that he feels have been largely ignored.

limited liability for fund managers and corporations - they would want to share profits, but not losses. for instance, a trading strategy may make 20% gains 99% of the time. a trader/firm with limited liability may back this strategy as they hardly have anything to lose, whereas the investor may be scared over the chance of that 1% odds showing up. ku suggests that rather than the current hedge fund 20-80 standard, a fund manager can do this. set up a deposit, such as 10% of fund capital, by using their own money. if there is loss, then their money would be used to offset the losses. in return, the fund manager can ask for a higher profit sharing such as 40-60 instead of the current 20-80 hedge fund standard. this practice is common among China's privately held funds which are similar to US hedge funds.

Kou also talks about the up-tick rule that is used to halt price declines when the market is in a panic mood. this rule was ruled out during the crisis. in spring 2009, if prices go up, investors of both house and equity markets use the inflated asset prices to borrow more money. this often results in unreasonable leverage ratios before the asset bubble bursts. Kou suggests creating certain formula for the margin requirement that takes into consideration market bubbles. say, instead of using the inflated asset or housing market prices, cap the growth of the prices at no more than the inflation-protected treasury bonds. this will prevent investors from having high leverage ratios during a bubble.

in fact, Kou says that too many financial engineering graduates are in the Wall Street. With hardly any training, these fellows are selling multi-billion-dollar derivatives. to balance the supply and demand at Wall Street, one can either reduce compensation or create new job opportunities by introducing more complex financial derivatives. they help make money most of the time, but are wrecked during unfortuante periods. Prestigious professions such as doctors and lawyers have considerable experience before handling big things and they need a license too. Traders too need to have extensive training and perhaps, a license!

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