Macquarie Bank and UNSW announce joint project to bring mathematical theory to market

15 April 2007

Macquarie Bank and the University of New South Wales (UNSW) today announced a joint project to develop and apply new mathematical technologies to value complex financial products.

The project, supported by an Australian Research Council (ARC) Linkage Grant, aims to manage the risk associated with complex financial products by devising faster and more accurate methods for their valuation.

Doug Moss, Division Director of Macquarie Bank’s Quantitative Applications Division, said finance sector products are becoming increasingly complex and there is a need for faster and more accurate valuation tools to meet modern demands.

"The finance industry continues to develop more complex structured offerings to meet market demand but is finding itself restrained by the time it takes to do the complex risk calculations associated with those products," Mr Moss said.

"This joint venture between UNSW and Macquarie Bank is aiming to develop new algorithms that can be used in financial services software applications to reduce the time taken for complex risk calculations from minutes to seconds - without compromising accuracy.

"This will not only lead to an increase in the quality and number of financial products available to the public but will help ensure Australia's financial services sector stays at the cutting edge of innovation and international competitiveness in this high value sector."

Mr Moss said Macquarie Bank would be working with researchers from UNSW's ARC Centre of Excellence for Mathematics and Statistics of Complex Systems (MASCOS), a national research centre with a major node in Sydney.

As well as the Australian Research Council, MASCOS is also supported by the NSW Government, which in its recent innovation statement committed to developing NSW's innovative capacity in a number of key economic sectors, including financial services.

"Financial services is NSW’s fastest-growing sector and Sydney’s financial services sector is now, on some measures, nearly half that of global-powerhouse London, and more than one-third that of New York," Mr Moss said.

"The global economy, expansion of funds management and the development of new and more advanced financial services products are helping propel continued growth and development, which Australia needs to be a part of through innovative research projects like this.

"For example, innovations in popular structured equity products involving large baskets of equities, which were developed in the late 1990s, would have developed far quicker if mathematical methods as fast as those we are now researching were available 10 years ago.

"The issue with these types of products is how to rapidly and accurately calculate their sensitivity - popularly termed ‘greeks’ - to potential changes in the characteristics of each of the stocks in the basket.

"Baskets containing large numbers of stocks have historically presented challenges to the conventional methods of calculating ‘greeks’, and this has held back the development of this important segment of the financial markets.

"Our aim is to develop new mathematical methods that can meet these types of challenges and grow the potential of the financial services sector."

An important existing workhorse for valuing complex financial products is the "Monte Carlo" method, which relies (as the intriguing name suggests) on gambling, or chance. More accurately, it relies on repeated random choices. For example, think of tossing a fair coin. After many tosses the number of heads is almost certainly close to half the number of tosses. The Monte Carlo method extends that simple idea into a powerful computational algorithm used every day by financial institutions around the world. Although effective, Monte Carlo methods are too slow for many practitioners in the financial world.

Macquarie Bank’s partners at UNSW are experts in "quasi Monte Carlo" methods, which aim to better Monte Carlo. The underlying idea is that in the long run a good design should always beat random choices.

The UNSW MASCOS team is led by Scientia Professor Ian Sloan, who is President of the International Council for Industrial and Applied Mathematics and has wide experience in the applications of mathematics to science and industry, and increasingly to the finance industry.

Professor Sloan said: "For us it is tremendously exciting to apply methods born in the cradle of mathematical theory to hard problems coming from the market, and to do so with a partner of the calibre of Macquarie Bank.

"This is an example of smart science partnering with industry to develop practical ways to boost the international competitiveness of a key sector of our economy."

Lisa Jamieson
Public Relations
Macquarie Bank Limited
Tel: (612) 8232 6016
Mobile: 0416 237 332