Recognizing the strengths and interests of the faculty at Rice University, CoFES has identified the following key research areas as its initial areas of interest:
- Credit Risk Management
- Pricing Financial Derivatives
- Emerging Markets
- Energy Markets
- Political Risk: The Impact of Politics on World Finance:
- Risk Fundamentals and Integration of Risk
The research areas emphasized by CoFES are dynamic and will evolve as the research paths of the faculty and students and the opportunities presented to CoFES evolve.
Brief Description of Research Areas:
Credit Risk Management: Credit risk measurement and management is gaining increasing attention from practitioners and academics. Since 1990, the markets have experienced several credit “events” including a global credit and liquidity crunch and industry-specific shocks. At the same time, the tools available to manage credit risk have increased with the proliferation of debt securitization, structured products and the introduction of credit derivatives. The statistically modeling of credit risk in an integrated fashion, however, has lagged behind efforts to characterize other financial risks. This is in no small part due to the paucity of relevant data and the necessity of advancing statistical techniques available to assess the extremes of the distribution systematically in conjunction with other financial risks and liquidity risk. An important research mission of the CoFES faculty will be applying a systems approach to measuring and managing credit risk based on advanced simulation techniques.
Pricing Financial Derivatives: Rice CoFES plans a research program that involves developing models that combine the best features of the theoretical and simulation approaches. Theoretical modeling attempts to identify structural determinants of prices that are likely to remain relatively stable in the face of shocks, or changes that have not previously been experienced. Through simulation we can imbed theoretical constructs within stochastic models building descriptively accurate micro models that will be aggregated to the macro level. The end result is a systems level model that encapsulates the major advantages of both the theoretical and heavily empirical approaches to modeling. Furthermore, CoFES will pursue research in nonlinear and heteoreogeneous stochastic models including stochastic models of volatility. There is significant research effort underway on modeling issues related to discretely observed continuous time stochastic models which in turn leads to optimal pricing strategies.
The Newest Financial Market: Energy: In the U.S. and many other developed economies, deregulation of the energy industry has created a new set of spot markets in energy commodities such as natural gas and electricity. The development of these dynamic and uncertain markets has been accompanied by the introduction of new financial derivatives including complex swap contracts, cross-market instruments and exotic options. The center of the spot and derivative markets in energy commodities is Houston, joining New York (stocks) and Chicago (commodities) as the nation’s third financial center. U.S. energy corporations must make the transition from drill-and-provide scenarios at relatively stable pricing to optimal real-time trading of their commodity. Additionally, recently developed markets in environmental resources, such as the market for sulfur dioxide emission permits, are directly related to the transition of the energy industry. Such markets have introduced a new set of financial risks that have in turned spawned a demand for contracts to efficiently share those risks. Pricing models as well as the effects of deregulation is a focus of CoFES research.
E-merging Market: E-commerce: Real-time pricing of goods is not limited to energy markets but is becoming more prevalent with the growth of e-commerce. Companies exist solely as Internet brokers of goods and services. For example, consider eBay.com, where commodities are given relative rather than fixed values. Real-time pricing models and strategies of commodities will become critical to e-commerce markets as they develop over the next decade.
Political Risk: The Impact of Politics on World Finance: The study of international conflict is related to the stability of nations and their financial markets. Recent national and world events have highlighted the close ties between economic prosperity and political stability. How do conflicts influence markets and vice versa? Although the end of the Cold War has reduced the threat of nuclear holocaust, armed conflict between nations continues to be a significant problem, and the proliferation of weapons of mass destruction and escalation of terrorist activities may reinstate previous fears. Financial markets are vulnerable to direct and intentional manipulation by external governments or organized groups seeking to destabilize the world economy. Financial markets may also reveal information about potential international conflicts. Coupling of quantitative investigations of financial indicators and international conflict as well as terrorism activities will bring needed insight to this complicated arena.
Risk Fundamentals and the Integration of Risk Analyses In the last several years financial risk identification, measurement and management has become a highly quantitative, statistical endeavor for many economic agents. Value-at-Risk is now a common measurement across firms of all types and is even readily available for the individual investor. The wide-spread use of statistical analysis to measure risk brings with it the potential of fooling decision makers with a false precision. While a broad foundation of risk measurement has been built, there is a need to go back to an investigation of the fundamental characterization of risk – what is the appropriate definition and unit of risk to measure and manage for various economic agents.
At the same time that risk fundamentals are being reconsidered, the tools available to apply to measuring risk in an integrated fashion – and in real time – must be advanced. Today, enterprise-wide risk management that truly addresses the risks faced by the firm in a dynamic fashion is not feasible. The development of advanced statistical and computing techniques and applications that can address the integrated financial and operating risk of the firm considering both a dynamic market environment and the real options embedded in the firm’s operating and strategic responses is an important area of inquiry for CoFES.