Berman GS ’94 explains market swings

On May 6, 2010, a flash crash hit the stock market, causing the Dow Jones Industrial Average to plunge roughly 600 points in a matter of minutes. The benchmark index recovered most of the loss 20 minutes later, leaving many market experts struggling to make sense of the extreme price changes.

Berman, a senior advisor to the director of the division of trading and markets at the Securities and Exchange Commission, played a key role in producing a long-awaited document that detailed how the crash occurred. The joint report, issued with the Commodity Futures Trading Commission, was released last Friday.

Though Berman did not comment specifically on the investigation because of his role within the SEC, he said that the skills he developed while completing research in neutrino physics — the ability to recognize patterns within the messiness of real data, for example — transferred well into his subsequent work.

“It was probably one of the most energizing and exciting projects that I’ve ever worked on — and that includes all the way back to my work in physics,” he said of the report, which concluded that a mutual fund’s $4.1 billion computerized sale and various reactionary events brought about the sudden fall and rise in stock prices.

Some University professors said the report drew attention to many concerns about the current state of the financial markets.

The report found that high-speed computerized trading had a direct connection to the flash crash, though it has been praised in recent years for its speed and cost-effectiveness.

“I don’t think the markets should be a gambling spree,” said Robert Vanderbei, chair of the operations research and financial engineering department, regarding high-frequency trading and the portfolio management techniques that it has fostered. “It should be a way of investing.”

Many of the approaches enabled by modern technology that are used by individual traders and funds, such as dynamic hedging, are well known strategies that have long been popular in business schools, economics professor Hyun Shin said. The flash crash has served as “another reminder of the fragility of liquidity” in the modern markets, he added.

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In light of these issues, the impact that the SEC and CFTC report will have on future financial regulation policies remains to be seen.

“How often are we going to see this type of event occur?” ORFE professor Rene Carmona said. “My fear is that from what I’ve read, the general consensus is that this is just one trade, one isolated event, and let’s continue to do business as usual.”

While the SEC and CFTC report is not a policy document, the findings could play a role in future policy considerations. The increasing overlap between academic research on finance and real-world observations of the market could also influence the decisions of financial regulators.

“This is the cutting edge of academic finance now,” Shin said.