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Finance Teaching and Research after the Global Financial Crisis

Finance Teaching and Research after the Global Financial Crisis

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Finance Teaching and Research after the Global Financial Crisis Jayanth R. Varma W.P. No. 2011-03-02 March 2011 The main objective of the working paper series of the IIMA is to help faculty members, research staff and doctoral students to speedily share their research findings with professional colleagues and test their research findings at the pre-publication stage. IIMA is committed to maintain academic freedom. The opinion(s), view(s) and conclusion(s) expressed in the working paper are those of the authors and not that of IIMA. INDIAN INSTITUTE OF MANAGEMENT AHMEDABAD-380 015 INDIA INDIAN INSTITUTE OF MANAGEMENT AHMEDABAD circle5 INDIA
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Page No. 2 W.P. No. 2011-03-02 IIMA circle5 INDIA Research and Publications Finance Teaching and Research after the Global Financial Crisis Jayanth R. Varma * Abstract Finance has come in for a great deal of criticism after the global financial crisis of 2007 and 2008. Clearly there were serious problems with finance as it was practiced in the years before the crisis. To the extent that this was only a gap between theory and practice, there is a need for finance practice to go back to its theoretical roots. But there is a need to re-examine finance theory itself. The paper begins with an analysis of what the crisis taught us about preferences, probabilities and prices, and then goes on to discuss the implications for the models that are used in modern finance. The paper concludes that the finance curriculum in a typical MBA programme has not kept pace with the developments in finance theories in the last decade or more. While a lot needs to change in finance teaching, finance theory also needs to change though to a lesser extent. Many ideas that are well understood within certain subfields in finance need to be better assimilated into mainstream models. For example, many concepts in market microstructure must become part of the core toolkit of finance. The paper also argues that finance theory needs to integrate insights from sociology, evolutionary biology, neurosciences, financial history and the multidisciplinary field of network theory. Above all, finance needs more sophisticated mathematical models and statistical tools. * Professor, Indian Institute of Management, Ahmedabad 380 015, India. Email: [email protected]
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Page No. 3 W.P. No. 2011-03-02 IIMA circle5 INDIA Research and Publications Finance Teaching and Research after the Global Financial Crisis 1. Introduction The global financial crisis of 2007 and 2008 (see Rajan, 2010, Roubini and Mihm, 2010 and Shiller, 2008) provides an opportunity for all finance professionals to introspect about the changes that need to be made in their discipline. Economists in general and financial economists in particular have come in for a great deal of criticism after the crisis. One well known book about the crisis was entitled “ECONned” (Smith, 2010), while a widely read columnist talked about the “formula that killed the world” (Salmon, 2009).
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