Dan diBartolomeo
Analysis of quantified news holds great promise for the purpose of managing risks
within financial institutions, and broadly across the financial system. By facilitating
rapid responses to flows of information that reveal risky circumstances, such systems
will meaningfully contribute to a lessening of the potential for financial crises. Monitor-
ing flows of information on markets and securities and the sentiment of their content is
an excellent indicator for potential dispersion of beliefs among investors, and hence the
potential for changes in the prices of assets.
However, the ability to respond quickly to information also increases the requirement
that the response be the right one. Responding instantly, but in the wrong fashion, can
foster disaster, just as driving a racing car requires greater precision than driving a golf
cart. As such, we must frame the general principles of our risk management effort in a
thoughtful and thorough fashion.
The first thing to focus on is the difference between risk management in a commercial
or investment banking setting, and risk management in an asset management setting.
Hedge funds are often in the middle on this spectrum, but we should at least understand
the issues.This is the biggest mistake people make. Banks are investing firm capital and
are highly leveraged with liabilities at call (a run on the bank). They are worried about
bankruptcy and regulatory problems.It is an issue of firm survival if a firm’s capital
should be sufficiently impaired.Quite differently, asset managers are investing other
people’s money. Those other people are typically long-term investors such as pension
funds whose liabilities are not at immediate call. Their liabilities are commitments for
future payments, not immediate ones. Even in a life insurer, people aren’t going to try to
kill themselves to collect early if the insurer is in financial trouble.
In setting up a risk management system, we need to make an explicit choice about
what risk we care about. For a bank we care about the bank’s risk. However, for agent
asset managers, do we really care about the risks for our investors, or do we really care
about how risky our revenue stream in business enterprise is? Do we really care about
helping investors meet their financial goals, or are we more worried about being fired as
a manager by a client because we have a period of poor performance?
Obviously, there is an ethical issue here, but in many asset management firms the
revenue aspect takes precedence. Our suggestion is to focus on the client’s portfolio risk
The Handbook of News Analytics in Finance Edited by L. Mitra and G. Mitra
#2011 John Wiley & Sons