INTRODUCTION TO CRITICAL THINKING IN FINANCIAL RISK MODELLING
Course Purpose & Objectives
The goal of this course is to equip students with critical thinking skills in finance, particularly in financial theory models and risk modelling. The course schedule will provide students with cognitive techniques and critical thinking tools to improve understanding of financial models that have a large societal and environmental impact. Upon completion of this course, students will have developed higher level thinking processes that will enable them to better address the issues facing the ecological transition of finance, make better decisions in model choices, and make better qualitative creative recommendations to business and industry stakeholders.
The methodology used is based on the addressing of financial problems by sociology and philosophy of science. Students taking this class will gain an in-depth understanding of philosophical notions that bear relevance to financial risk modelling. With support from sociology and philosophy of science, they will develop an independent mindset that enables them to better add value to data, interpret trends in financial modelling, understand the interaction between models and people, and take a broader financial perspective to drive the business
More precisely, after completing the course, students are expected to be able to:
- Explain the main characteristics of the Brownian representation and its impact to environmental issues.
- Use critical thinking skills to identify epistemological issues in all financial modelling fields such as the problem of assumption corroboration that plagues all financial theories.
- Start thinking critically about how financial knowledge is produced and accumulated, and how it might be contributed to in the future from a sustainable and ecological perspective.
- Analyse how the different dynamics of knowledge success or fail to explain the persistence of a conceptual framework despite its drawbacks, and understand how to prepare a future conceptual framework for the purpose of the SDGs.
This course is composed by a combination of frontal lectures and group presentations.
Course Contribution to program objectives
MSC1. Developing a strategic perspective based on a solid understanding of management foundations and techniques.
MSC4. Demonstrate critical thinking in the specific industrial or function of specialization and the ability to excel in a culturally diverse environment.
Course Contribution to Application of Critical Thinking
The course will start with the example of the 2008 financial crisis to introduce students to the notion of epistemic ethics. We will describe the two ways in which mathematical theories of risk become the actual reality of professional practices: through speech acts and through management devices. Then we will study how the risk culture leads to a particular decision, by showing through the history of science how a risk culture is shaped by mathematical finance. This will allow us to introduce two risk cultures in finance, Brownian finance and non-Brownian finance. The history of the Brownian representation in finance will allow us to raise the puzzle of its maintenance despite its permanent invalidation by statistical tests. The course will then provide an introduction to Mandelbrot’s fractal geometry, with the aim of sketching out what mathematical fractal finance (everywhere discontinuous) could be.
The course will conclude with reflections on how to reconcile finance and nature in order to align finance with the SDGs.
Course Contribution to Sustainable Development Goals
The Sustainable Development Goals (SDGs) define 17 priorities for socially equitable, environmentally safe, economically prosperous, inclusive and predictable development by 2030. They were adopted in September 2015 by the UN as part of the framework of the 2030 Agenda.
This course, like all Kedge courses, meets Sustainable Development Goal 4 (Quality Education). It can also meet other inclusive and sustainable objectives such as:
- 8. Decent Work and Economic Growth
- 10. Reduced Inequality
- 11. Sustainable Cities and Communities
Critical thinking, fractal modelling methods, sustainable finance, performativity, risk modelling, SDGs.
Course Contents and Timetable
|1 & 2||Post-positivistic ethical perspective in finance||
Revisiting the 2008 financial crisis
• The movie Margin Call (2011): discussion between the risk manager and the CEO
• Epistemic ethics: Black Swan vs. Financial Logos
• The making of stock market representation
• The choice of randomness as an epistemic act
|3 & 4||The performativity of randomness: neoclassical finance at work||Understand the relation between neoclassical finance and randomness
• Randomness as quantification convention: the financialised tools
• Randomness as speech act: the financial “Logos”
|5 & 6||Mental models and risk culture in neoclassical finance||Flush out the assumptions of neoclassical finance models
• Modern portfolio theory and diversification
• CAPM and benchmarks
• Efficient market hypothesis and risk-neutral world
• Option pricing theory and replicating portfolio
• Market consistent valuation and prudential regulation
|7 & 8||Non-Brownian randomness and sustainable finance||Understand the discontinuities in financial risk modelling
• The leptokurtic crisis and the discontinuous turn
• Brownian representation and extreme values: the problem
• The “80/20 rule” and the scaling laws in nature
• Financial risk modelling and sustainability
Course Material and Readings
Sessions 1 & 2. Post-positivistic ethical perspective in finance
De Bruin, Boudewijn. 2015. Ethics and the global financial crisis: why incompetence is worse than greed. Cambridge: Cambridge University Press.
Cassidy, Rebecca. 2009. ‘Casino capitalism’ and the financial crisis”. Anthropology Today, 25(4): 10-13.
Embrechts, Paul. 2009. “Did a Mathematical Formula Really Blow up Wall Street?” https://www.actuaries.org/ASTIN/Colloquia/Helsinki/Presentations/Embrechts.pdf
MacKenzie, Donald; Spears, T.C. 2014. “The formula that killed Wall Street’: The Gaussian copula and modelling practices in investment banking”. Soc. Stud. Sci., 44: 393-417.
Salmon, Felix. 2009. “The Formula that Killed Wall Street”. Wired: San Francisco, CA, USA.
Sessions 3 & 4. The performativity of randomness: neoclassical finance at work
Content: Using philosophy to understand the financialisation of “real” economy by mathematical risk modelling
- Financialised risk theories as speech acts: the financial “Logos”
Austin, James L. 1955. How to do Things with Words. Clarendon Press: Oxford, UK.
Brisset, N. 2018. “Models as speech acts: The telling case of financial models”. J. Econ. Methodol. 25: 21-41
Walter, Christian. 2016. “The financial Logos: The framing of financial decision-making by mathematical modelling”, Research in International Business and Finance, 37: 597-604.
Content: Using sociology to understand the financialisation of “real” economy by mathematical risk modelling
- Financialised tools: the socio-technical instruments of financial practices
- The quantification conventions
Callon, Michel. 1998. “The Embeddedness of Economic Markets in Economics”. In The Laws of the Markets. Blackwell. Oxford: Oxford University Press: 1-57.
Chambost, Isabelle, Marc Lenglet, Yamina Tadjeddine. 2019. The Making of Finance Perspectives from the Social Sciences, Routledge.
Chiapello, Eve. 2020. “Financialization as a socio-technical process”. In The Routledge International Handbook of Financialization. Taylor & Francis: New York, NY, USA, pp. 81-91.
Chiapello, Eve and Walter, Christian. 2016. “The three ages of financial quantification: A conventionalist approach to the financier’s metrology”. Hist. Soc. Res. 41: 155-177.
Desrosières, A. 2008. Pour une sociologie historique de la quantification. Presses de l’Ecole des Mines: Paris.
MacKenzie, Donald. 2006. An Engine Not a Camera. How Financial Models Shape Markets. MIT Press: Cambridge, MA, USA.
MacKenzie, D; Muniesa, F.; Siu, L. 2007. Do Economists Make Markets? On the Performativity of Economics. Princeton University Press: Princeton, NJ, USA.
Muniesa F. 2015. The Provoked Economy. Economic Reality and the Performative Turn; Routledge: Abingdon, UK.
Svetlova, E. 2018. Financial Models and Society. Villains or Scapegoats. Edward Elgar Publishing: Cheltenham, UK.
Sessions 5 & 6. Mental models and risk culture in neoclassical finance
Content: Using history of science to flush out the assumptions of unsustainable neoclassical finance
- Mental models in finance: the principle of continuity and the theory of average
Walter, Christian. 2013. Le modèle de marche au hasard en finance. Ch. 4
Content: The risk culture of finance
- Two risk cultures: unsustainable and sustainable (smooth/rough and short term/long term)
- “Brown finance” and “green finance”
Jorion, Philippe. 2007. Value-at-Risk. The New Benchmark for Managing Financial Risk. 3rd ed., New York: McGraw-Hill.
Knorr Cetina, K. 1999. Epistemic cultures. How the Sciences Make Knowledge; Harvard University Press: Cambridge, MA, USA.
Mantzavinos, C. 2001. Individuals, Institutions, and Markets. Cambridge University Press: Cambridge, UK.
Sessions 7 & 8. Non-Brownian randomness and sustainable finance