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Making sense of market madness



Federico Bandi
Federico Bandi of the Johns Hopkins Carey Business School develops mathematical models to predict the behavior of volatile financial markets. Photo: Bill Denison

When faced with wholly innocent small talk such as, "So, what do you do for a living?" Federico Bandi frequently stops those that approach him in their tracks.

"I tell them that I write mathematical models," he says, breaking into a big smile, "and that usually ends the conversations."

The soft-spoken Bandi arrived at the Johns Hopkins Carey Business School with research based on the work of New York University's Nobel Prize-winning econometrician Robert Engle. What Engle began, Bandi and perhaps a dozen colleagues around the world have built upon. Think of it as Financial Econometrics 2.0: the use of sophisticated mathematical models to predict how individual financial products and overall markets will behave over time.

Increased use of automated stock trading computer programs that trigger high-frequency transactions in microseconds has only complicated attempts to develop reliable models for market behavior. In 1982, the New York Stock Exchange traded 100 million shares in a single day for the first time in its history. On May 6, 2010, computerized financial controls failed, allowing a frenzy of high-frequency transactions that sent the Dow Jones average plummeting 600 points. On that day, there were 2.6 billion shares traded.

It's Bandi's research that seeks to make sense of this mathematical market madness.

"The idea is relatively simple," says Bandi, who teaches courses to MBA students on financial valuation and analysis. "There are quantities of items that people are interested in and talk about all the time, like inflation rates, interest rates, and stock returns. You can actually write down mathematical expressions that tell you rather clearly how these objects move around and evolve as time goes by."

With Bandi's growing recognition within his field—his papers have been cited in economics journals more than 1,000 times—there's a sense that his influence is being felt beyond the walls of academia. Former Carey professor Celso Brunetti, who now works at the Federal Reserve, calls Bandi an "elegant" mathematician whose work is well-known by people at the Fed.

"One of his main contributions is he basically developed the theory and the application of how to measure the volatility of financial assets," says Brunetti. "This is a major breakthrough, extremely important for policymakers when they have to regulate markets; for CEOs running a company who want to know the volatility of crude oil, for example; and for portfolio managers because they need to compute how risky is their portfolio."

When asked where he likes to work, Bandi waves a dismissive hand at his computer screen. "That's where I answer my emails. The tedious stuff," he says. "I like to work in unusual circumstances." He prefers to hop into his car, flip on anything from classical music to salsa, and think while he drives. Or take a long walk and think some more. Or simply go to sleep ... and think still more.

"Being in those everyday situations helps the process because it stays with you, you're sort of metabolizing it a lot better," says Bandi. "I've had multiple occasions when I've gone to bed, thought about something I'm working on, and woken up in the morning with a reasonable solution. There's nothing magical about it; it's just an indication that your brain keeps on working."

Read more in ONE Magazine

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