04 Jan 2010
As part of the new ‘Up Close’ Student Speaker Series, Professor Sir Andrew Likierman, Dean, chaired a panel that included Professors Julian Franks, Richard Portes and Lakshmanan Shivakumar. Soros shared his latest thinking with opening comments relating to his most recent research and his thoughts on economic hypotheses and risk management models – in particular his theory against the efficient market hypothesis.
In response to Soros’s comments, Professor Richard Portes noted that negative feedback mechanisms do appear in existing economic models. Economic systems are recognised to behave differently when they are far from equilibrium, as has been the case recently. Soros’s theory of Reflexivity (in which actions and data influence each other reciprocally) is consistent with some but not all economic theories. Referring to the crisis, Richard argued that deregulation of the financial system in the past decade removed key ‘firewalls’, so more and better regulation is needed. He agreed with Soros that policymakers should have rescued Lehman Brothers and that banks are too big.
Professor Julian Franks suggested a different interpretation to Soros’s theory regarding the efficient market hypothesis, and noted that there were several anomalies in the efficient markets hypothesis (or ‘missing risk factors) that have been suggested; recent financial ‘earthquakes’ raise further questions. However, a strict acceptance of Soros’s theory would suggest that our risk/return theories are invalid; our NPV rules are not useable, and our theories on diversification are also incorrect. Hence, caution should be exercised rather than completely dismissing these fundamental theories of financial economics.
Professor Lakshmanan Shivakumar (Shiva) noted that the Efficient Markets Hypothesis is often confused as implying all investors are rational. He clarified that the Efficient Markets Hypothesis merely stated that one could not create unusual profit using the information already available, and that the number of people who do not beat the market proves that the hypothesis is a good description of the stock markets for most part. At the same time, Shiva noted that whilst many of the mutual funds do not beat the market, Soros’s track record proves that the hypothesis has its limitations.
Shiva also noted that behavioural economics needed to be considered when attempting to explain the markets. He agreed with examples given in Soros’s lectures, which were consistent with his own theory called the ‘catering theory of earnings management’ - when investors are particularly responsive to earnings surprises, managers boost reported earnings either via acquiring companies, changing their investment strategies or managing accrual estimates.
Soros concurred with the faculty members and confirmed that he was not dismissing economics, but rather that having different hypotheses might give better results given the uncertainty. He also noted that he came out ahead during the crisis by hedging his bets, although he acknowledges that he overplayed his hand and perhaps took too many risks.
Soros acknowledged his concern that people in the finance industry (from both the private and public sectors ) have still not understood the lessons of the crisis, which he believed was preceded by a period of great moderation without much volatility, which has led to increased risk-taking. Looking ahead, Soros stated that he believed regulators should not be confined to just looking at controlling the money supply; they need to look at controlling credit.
Students in attendance participated in a lively question and answer session, exploring Soros's position on current issues and listening to the thinking behind his legendary ideas. Faculty members on the panel added their own critiques to the discussion, exploring how new ideas may contribute to different modes of thinking and behaviour.