Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Open source research in finance

Eighteen months ago, Bill Ackman of the Pershing Square hedge fund
released his “Open Source Model” providing detailed data on
30,499 tranches of 534 CDOs to which the big US bond insurers (MBIA
and Ambac) had exposure. On the basis of this model, he claimed that
MBIA and Ambac were insolvent. At the time, many regarded it as a
publicity stunt; after all Ackman was heavily short these insurers and
was merely talking his book.

While many read Ackman’s
, few bothered to download the actual data. This was partly
because the data was really huge (110 megabytes) and the letter warned
that each recalculation of the model took about half an hour on a
typical workstation. Moreover, the yousendit
where the data was uploaded expired within a few days. In any
case, after the near-collapse of the bond insurers, people lost interest in
the model.

However, last month Benmelech and Dlugosz published a paper on what they called
“The Credit Rating Crisis” which relies partly on this
data to document the failures of the rating agencies. Among other
things, Benmelech and Dlugosz show that CDOs rated by only one rating
agency were more likely to be downgraded than those rated by two or
more agencies. They also confirm what was well known anecdotally about
one particular rating agency being worse than the others.

This suggests that open source research can work in finance. One
way to get transparency about the balance sheet of financial
institutions might be for the regulators to create large detailed
databases which anybody can analyse. I think several gigabytes of data
would do the job, but even if the data grows to a terabyte or more, it
would be well worth the effort.

Updated: Changed “collapse of the bond insurers” to “near-collapse of the bond insurers”


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