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CFA Institute Annual Conference | Day 1

Sean Barron, Portfolio Manager at Delta Trust and CFA Institute Member, attended the CFA Institute Annual Conference on May 6-9 in Chicago.  Below are his notes and comments from the day’s presenters…

James Montier – GMO UK Ltd.

4 problems that led to crisis

Bad Models

Bad Policies

Bad Incentives

Bad Behavior

Finance vs. Physics – You don’t find physicists betting that a feather and a brick will hit the ground at the same time in the “real world”.

Bad Models

CAPM – Volatility isn’t risk! Essentially the model says that the only risk is volatility and ignores liquidity and leverage.

If everyone is using the same model, you move from institutional risk to systematic risk.

Referenced Dorman and Wilmott: The Modelers’ Hippocratic Oath

Black swans are a matter of perspective:

Black Swans – Unpredictable, massive impact, and ex-post rationalization

Predictable surprise – At least some were aware of the problem, the problem gets worse over time, and eventually explodes into crisis

Five impediments to recognizing predictable surprises – over optimism, the illusion of control, self-serving bias, myopia, and intentional blindness (to which he stated something along the lines of: If your pay depends upon not seeing something, it is not usually seen. – i.e. the rating agencies)

How to fix financial modeling – take the modelers’ oath, seek more realistic models, interact with practitioners more, and a lot more common sense and a little less complex mathematics

How to fix the practice of finance – define risk properly as the permanent impairment of capital (Warren Buffett is famous for stating this), know the limits of your models and don’t exploit them, focus on the long term, study financial history (including a knock on the CFA body of knowledge for not including this more), and learn to look for predictable surprises

How to fix policy and the regulation of finance – capital adequacy should be contra-cyclical and central banks should “lean against the wind”

Read about the rest of Sean’s experience at the conference – Day 2 and Day 3.

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