A study co-authored by MIT Sloan Prof. Andrew Lo concluded that under certain conditions, all it takes to fan the flames [of a financial crisis] is for a critical mass of people to extract money from their homes in the form of home equity loans, sales and "cash-out" refinancing.
Andrew W. Lo, director of the Massachusetts Institute of Technology's Laboratory for Financial Engineering, breaks down the hot debate brewing about the cause of the current financial crisis. Learn the arguments for and against the claim that complex financial securities and the mathematical models used to manage them should take the blame. Was it systematically programmed or just human nature?
MIT Sloan Prof. Andrew Lo of MIT's Sloan School of Management points out that in the physical sciences three laws can explain 99% of behavior, whereas in finance 99 laws can explain at best 3% of behavior.
MIT Sloan Prof. Andrew Lo says radical compensation reform would be no easy feat given the complexities of most financial institutions and the politics surrounding this effort. "It will take more than bonus caps if we ever hope to create a more stable and robust financial system that will be free from the tyranny of bubbles, crashes, and credit cycles," says Lo.
When a bridge over a river collapses, the engineers who built the bridge have to take responsibility. But typically, critics call for improvement and smarter, better-trained engineers—not fewer of them. The same pattern seems to apply to financial engineers. At MIT, the Sloan School of Management is starting a one-year master's in finance this fall because the field has become too complex to be adequately covered as part of a traditional MBA program, and because of student demand. The new finance program, MIT Sloan Prof. Andrew Lo noted, had 179 applicants for 25 places.
The basic principles of asset allocation need to be revised," says MIT finance professor Andrew Lo. He and other experts argue that since market volatility is rising, you must now own other assets—such as hedge-fund-like investments—in addition to stocks and bonds to manage risk. And you must be prepared to shift your mix tactically from time to time. "You need to be proactive and adjust as the market changes."
In this letter to the editor, MIT Sloan Prof. Henry Birdseye Weil says that MIT Sloan Prof. Andrew Lo's article, 'Why animal spirits can cause markets to break down,' makes "an extremely important point. Models that assume, at least implicitly, that decisions-makers understand the structure of the market and how it produces the dynamics that can be observed or might potentially occur can be dangerous simplifications and seriously miselading."
One economist leading the effort to define the new paradigm is Andrew Lo, of the Massachusetts Institute of Technology, who sees merit in both the rational and behavioural views. He has tried to reconcile them in the "adaptive markets hypothesis," which supposes that humans are neither fully rational nor psychologically unhinged. Instead, they work by making best guesses and by trial and error. If one investment strategy fails, they try another.