Publications
From ELIZA to ChatGPT: The Evolution of NLP and Financial Applications
2023Natural language processing (NLP) has revolutionized the financial industry, providing advanced techniques for the processing, analyzing, and understanding of unstructured financial text. The authors provide a comprehensive overview of the historical development of NLP, starting from early rules-based approaches to recent advances in deep learning–based NLP models. They also discuss applications of NLP in finance along with its challenges, including data scarcity and adversarial examples, and speculate about the future of NLP in the financial industry. To illustrate the capability of current NLP models, a state-of-the-art chatbot is employed as a co-author of this article.
Deep-Learning Models for Forecasting Financial Risk Premia and Their Interpretations
2023The measurement of financial risk premia, the amount that a risky asset will outperform a risk-free one, is an important problem in asset pricing. The noisiness and non-stationarity of asset returns makes the estimation of risk premia using machine learning (ML) techniques challenging. In this work, we develop ML models that solve the problems associated with risk premia forecasting by separating risk premia prediction into two independent tasks, a time series model and a cross-sectional model, and using neural networks with skip connections to enable their deep neural network training.These models are tested robustly with different metrics, and we observe that our models outperform several existing standard ML models. A known issue with ML models is their ‘black box’ nature, i.e. their opaqueness to interpretability. We interpret these deep neural networks using local approximation-based techniques that provide explanations for our model’s predictions.
Leveraging Patient Preference Information in Medical Device Clinical Trial Design
2023Use of robust, quantitative tools to measure patient perspectives within product development and regulatory review processes offers the opportunity for medical device researchers, regulators, and other stakeholders to evaluate what matters most to patients and support the development of products that can best meet patient needs. The medical device innovation consortium (MDIC) undertook a series of projects, including multiple case studies and expert consultations, to identify approaches for utilizing patient preference information (PPI) to inform clinical trial design in the US regulatory context. Based on these activities, this paper offers a cogent review of considerations and opportunities for researchers seeking to leverage PPI within their clinical trial development programs and highlights future directions to enhance this field. This paper also discusses various approaches for maximizing stakeholder engagement in the process of incorporating PPI into the study design, including identifying novel endpoints and statistical considerations, crosswalking between attributes and endpoints, and applying findings to the population under study. These strategies can help researchers ensure that clinical trials are designed to generate evidence that is useful to decision makers and captures what matters most to patients.
Financial Intermediation and the Funding of Biomedical Innovation: A Review
2023We review the literature on financial intermediation in the process by which new medical therapeutics are financed, developed, and delivered. We discuss the contributing factors that lead to a key finding in the literature—underinvestment in biomedical R&D—and focus on the role that banks and other intermediaries can play in financing biomedical R&D and potentially closing this funding gap. We conclude with a discussion of the role of financial intermediation in the delivery of healthcare to patients.
Social Contagion and the Survival of Diverse Investment Styles
2023We examine the contagion of investment ideas in a multiperiod setting in which investors are more likely to transmit their ideas to other investors after experiencing higher payoffs in one of two investment styles with different return distributions. We show that heterogeneous investment styles are able to coexist in the long run, implying a greater diversity than predicted by traditional theory. We characterize the survival and popularity of styles in relation to the distribution of security returns. In addition, we demonstrate that psychological effects such as conformist preference can lead to oscillations and bubbles in the choice of style. These results remain robust under a wide class of replication rules and endogenous returns. They offer empirically testable predictions, and provide new insights into the persistence of the wide range of investment strategies used by individual investors, hedge funds, and other professional portfolio managers.
Quantifying the Impact of Impact Investing
2023We propose a quantitative framework for assessing the financial impact of any form of impact investing, including socially responsible investing; environmental, social, and governance (ESG) objectives; and other nonfinancial investment criteria. We derive conditions under which impact investing detracts from, improves on, or is neutral to the performance of traditional mean-variance optimal portfolios, which depends on whether the correlations between the impact factor and unobserved excess returns are negative, positive, or zero, respectively. Using Treynor–Black portfolios to maximize the risk- adjusted returns of impact portfolios, we derive an explicit and easily computable measure of the financial reward or cost of impact investing as compared with passive index bench-marks. We illustrate our approach with applications to biotech venture philanthropy, a semiconductor research and development consortium, divesting from “sin” stocks, ESG investments, and “meme” stock rallies such as GameStop in 2021.
Explainable Machine Learning Models of Consumer Credit Risk
2023In this work, the authors create machine learning (ML) models to forecast home equity credit risk for individuals using a real-world dataset and demonstrate methods to explain the output of these ML models to make them more accessible to the end user. They analyze the explainability for various stakeholders: loan companies, regulators, loan applicants, and data scientists, incorporating their different requirements with respect to explanations. For loan companies, they generate explanations for every model prediction of creditworthiness. For regulators, they perform a stress test for extreme scenarios. For loan applicants, they generate diverse counterfactuals to guide them with steps toward a favorable classification from the model. Finally, for data scientists, they generate simple rules that accurately explain 70%–72% of the dataset. Their study provides a synthesized ML explanation framework for all stakeholders and is intended to accelerate the adoption of ML techniques in domains that would benefit from explanations of their predictions.
Optimal Financing for R&D-Intensive Firms (Working Paper)
2023We develop a theory of optimal financing for R&D-intensive firms. With only market financing, the firm relies exclusively on equity financing and carries excess cash, but underinvests in R&D. We use mechanism design to examine how intermediated financing can attentuate this underinvestment. The mechanism combines equity with put options such that investors insure firms against R&D failure and firms insure investors against high R&D payoffs not being realized.
Macro-Finance Models with Nonlinear Dynamics
2023We provide a review of macro-finance models featuring nonlinear dynamics. We survey the models developed recently in the literature, including models with amplification effects of financial constraints, models with households' leverage constraints, and models with financial networks. We also construct an illustrative model for those readers who are unfamiliar with the literature. Within this framework, we highlight several important limitations of local solution methods compared with global solution methods, including the fact that local-linearization approximations omit important nonlinear dynamics, yielding biased impulse-response analysis.
Jack Bogle: Champion of the People
2022A tribute to John (Jack) C. Bogle, founder of The Vanguard Group, who passed away on January 16, 2019.
Estimation and Prediction for Algorithmic Models of Investor Behavior
2022We propose a Markov chain Monte Carlo (MCMC) algorithm for estimating the parameters of algorithmic models of investor behavior. We show
that this method can successfully infer the relative importance of each heuristic among a large cross-section of investors, even when the number of observations per investor is quite small. We also compare the accuracy of the MCMC approach to regression analysis in predicting the relative importance of heuristics at the individual and aggregate levels and conclude that MCMC predicts aggregate weights more accurately while regression outperforms in predicting individual weights.
Pandemic Readiness Requires Bold Federal Financing for Vaccines
2022Most people will experience a severe pandemic within their lifetime, and the world remains dangerously unprepared. In fact, scientists predict a nearly 50% chance––the same probability as flipping heads or tails on a coin––that we will endure another COVID-19-level pandemic within the next 25 years. Shifting America’s pandemic response capability from reactive to proactive is, therefore, urgent. Failure to do so risks the country’s welfare.
Getting ahead of the next pandemic is impossible without government financing. Vaccine production is costly, and these expenses will hinder industries from preemptively developing the tools needed to halt disease transmission. For example, the total expected revenues over a 20-year vaccine patent lifecycle would cover just half of the upfront research and development (R&D) costs.
However, research suggests that a portfolio-based approach to vaccine development — especially now with new, broadly applicable mRNA technology — dramatically increases the returns on investment while also guarding against an estimated 31 of the next 45 epidemic outbreaks. With lessons learned from Operation Warp Speed, Congress can deploy this approach by (i) authorizing and appropriating $10 billion to the Biomedical Advanced Research and Development Authority (BARDA) (ii) developing a vaccine portfolio for 10 emerging infectious diseases (EIDs), and (iii) a White House Office of Science and Technology Policy (OSTP)-led interagency effort focused on scaling up production of priority vaccines.
Financing Fusion Energy
2022The case for investing in fusion energy has never been greater, given increasing global energy demand, high annual carbon dioxide output, and technological limitations for wind and solar power. Nevertheless, financing for fusion companies through traditional means has proven challenging. While fusion startups have an unparalleled upside, their high upfront costs, lengthy delay in payoff, and high risk of commercial failure have historically restricted funding interest to a niche set of investors. Drawing on insights from investor interviews and case studies of public–private partnerships, we propose a megafund structure in which a large number of projects are securitized into a single holding company funded through various debt and equity tranches, with first loss capital guarantees from governments and philanthropic partners. The megafund exploits many of the core properties of the fusion industry: the diversity of approaches to engender fusion reactions, the ability to create revenue-generating divestitures in related fields, and the breadth of auxiliary technologies needed to support a functioning power plant. The model expands the pool of available capital by creating tranches with different risk–return tradeoffs and providing a diversified “fusion index” that can be viewed as a long hedge against fossil fuels. Simulations of a fusion megafund demonstrate positive returns on equity (ROE) and low default rates for the capital raised using debt.
World of EdCraft: Teaching Healthcare Finance at MIT
2022In this article, I describe my approach to dealing with the challenges and opportunities of synchronous online teaching during the Fall semester of 2020 in the specific context of a 90-student graduate course in Healthcare Finance at the MIT Sloan School of Management.
Hamilton’s rule in economic decision-making
2022Hamilton’s rule [W. D. Hamilton, Am. Nat. 97, 354–356 (1963); W. D. Hamilton, J. Theor. Biol. 7, 17–52 (1964)] quantifies the central evolutionary ideas of inclusive fitness and kin selection into a simple algebraic relationship. Evidence consistent with Hamilton’s rule is found in many animal species. A drawback of investigating Hamilton’s rule in these species is that one can estimate whether a given behavior is consistent with the rule, but a direct examination of the exact cutoff for altruistic behavior predicted by Hamilton is almost impossible. However, to the degree that economic resources confer survival benefits in modern society, Hamilton’s rule may be applicable to economic decision-making, in which case techniques from experimental economics offer a way to determine this cutoff. We employ these techniques to examine whether Hamilton’s rule holds in human decision-making, by measuring the dependence between an experimental subject’s maximal willingness to pay for a gift of $50 to be given to someone else and the genetic relatedness of the subject to the gift’s recipient. We find good agreement with the predictions of Hamilton’s rule. Moreover, regression analysis of the willingness to pay versus genetic relatedness, the number of years living in the same residence, age, and sex shows that almost all the variation is explained by genetic relatedness. Similar but weaker results are obtained from hypothetical questions regarding the maximal risk to her own life that the subject is willing to take in order to save the recipient’s life.