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Financial Systems vs. Systemic Risk: Creating a Common Picture for the Regulatory Community
Editor's Note: For more on MITRE's research into financial systems oversight, please see Less Risk, More Reward: Improving Bank-Default Predictions with Data Mining.
The financial meltdown of 2008 led to widespread calls for changes in the way the government tracks economic information. Different ideas have been proposed, including new computational approaches that can help safeguard the nation's financial system. "Regulators today are faced with managing exposure from financial risk that can come from many diverse and additive effects," says Charles Worrell, MITRE systems engineer and lead researcher on the project.
Due to the interconnectedness of the global financial system, it only takes a single component to put the entire system at risk. To improve the ability of federal agencies to manage systemic risk, MITRE is developing a variety of new analytic tools. Federal financial regulators and others in the financial industry and academia have expressed interest in MITRE's work on financial system oversight.
Worrell and his team focus on developing a modeling environment that can apply financial and economic data from a number of separate models to create a common understanding of basic financial scenarios for the regulatory community. Known as the Systemic Risk Program, this research integrates work from eight different research projects within the MITRE internal research program.
"Our efforts focus on bringing together an array of models that allow an aggregate view of the composite situation and enable unbiased comparisons of conflicting forecasts," Worrell says. "Our goal is not to generate a 'correct' answer, but to allow an unbiased comparison of several different answers."
As One Financial Institution Goes Down, So Do Others
Like falling dominos, systemic risk theoretically has no limits. It includes disruptions that will not stop at a few financial institutions and can imperil national economies. "It's hard for regulators to anticipate, measure, manage, and control systemic risk," he adds.
The traditional methods used to model financial systems only focus on individual sectors of the economy. "The primary disciplines involved are economics, finance, and accounting, but their findings are often viewed in stovepipes," Worrell says. "What we're trying to do is take advantage of MITRE's systems engineering strengths and capabilities to demonstrate a platform that could help regulators look across some of those different tools and sectors when trying to make a decision."
Worrell and his team represent a cross-section of MITRE research. "Many problems are better served by working across disciplines," he says. "We have formed interdisciplinary teams to attack these hard problems in ways that are new to the regulator community."
Merging Diverse Models to Predict a Financial Storm
The testbed for this effort is MITRE's Financial Modeling and Analysis Center, which provides the tools and methods to securely host and execute diverse models and economic data. These tools provide assessments of national systemic risk for the financial system.
"Instead of standalone analyses and stovepipes, the Financial Modeling and Analysis Center integrates data to take a holistic approach to examining the dynamics of the financial system for a user-defined scenario," says Group Leader Rajani Shenoy.
Much like a hurricane forecast, where disparate models converge to establish a basis for predicting a storm, the Systemic Risk Program gathers participants from the federal financial regulatory world, academia, and industry. The participants share financial and economic insights that result in an aggregated view of the economy. "Under this operating model, financial regulators might contribute information generally not available to the public," Worrell says. "Meanwhile, their university and industry counterparts contribute alternative views and data for the different aspects of the financial sector."
The model's anonymous environment also provides the collaborators with a mechanism to conduct a self-assessment against their peers, providing a win-win situation for all.
"We have reached out to several different collaborators to begin sharing some algorithms so that we can present their outputs and generate a view from across a community of interest," says Worrell. "The real value-added component comes from bringing the different collaborators together."
MITRE staff have presented their research from the Systemic Risk Program at several industry conferences. Last year, the team delivered papers at the Business Complexity and Global Leader Conference, the IEEE Computational Intelligence for Financial Engineering and Economics Conference, and the Society for Risk Analysis World Congress. The work will also be featured in the upcoming Systemic Risk Handbook published by the Cambridge University Press. As financial tools and models grow more sophisticated, there's hope that financial meltdowns will become a thing of the past.
—by Elvira Caruso
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Page last updated: November 30, 2012 | Top of page
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