tbs education webinar grow the pie

You are invited to participate in a webinar with Alex Edmans, Professor of Finance at London Business School and a leading expert on sustainable finance, about his award-winning book ”Grow the Pie: How Great Companies Deliver Both Purpose and Profit”.

The webinar will take place on Tuesday 28 March 17:00-18:00 Paris time and the moderator will be David Stolin, Professor of Finance at TBS Education.

The book, whose French edition was published last month, has been featured in numerous media outlets, including The Economist and the Financial Times. The one-hour webinar will be in English and will consist of a presentation by Professor Edmans followed by Q&A. Webinar participants will be able to ask questions through the chat function. Anyone interested in how companies can serve both society and their investors is welcome!

The Finance Crowd Analysis Project is offering an unrivaled meta-scientific view in empirical Finance. 164 research teams worked on this project, an exceptional number in this field. It involved researchers from 207 institutions and 34 countries including central bank economists.

2 TBS Education associate professors involved in #fincap

Two TBS Education associate professors, Anna Calamia and Debrah Meloso, are co-authors of the research paper Non-standard-errors coming from Fincap. Anna and Debrah are professors in the department of Economics and Finance and are affiliated to the Finance, Economics, and Econometrics research laboratory at TBS Education. Their research has focused on the functioning of financial markets and they are engaged in several other projects together.

The first crowd-sourced empirical paper in Economics/Finance

Have you ever wondered whether researchers using the same data set to address a unique research question would come to the same conclusions? Fincap tried to answer this complex question.

This innovative project attracted eminent researchers, including some from the most prestigious French finance department. Fincap was run by project coordinators Anna Dreber, Felix Holzmeister, Juergen Huber, Magnus Johannesson, Michael Kirchler, Albert J. Menkveld, Sebastian Neusuess, Michael Razen, and Utz Weitzel from the Stockholm School of Economics, the University of Innsbruck, and the Vrije Universiteit Amsterdam.


In statistics, samples are drawn from a population in a data-generating process (DGP). Standard errors measure the uncertainty in sample estimates of population parameters. In science, evidence is generated to test hypotheses in an evidence-generating process (EGP). We claim that EGP variation across researchers adds uncertainty: non-standard errors. To study them, we let 164 teams test six hypotheses on the same sample. We find that non-standard errors are sizeable, on par with standard errors. Their size (i) co-varies only weakly with team merits, reproducibility, or peer rating, (ii) declines significantly after peer-feedback, and (iii) is underestimated by participants.

TBS Education’s Inspiring Guest project is in the spotlight for its innovative approach to teaching finance. After winning the Best Session Award at the AOM Teaching and Learning Conference and the Best Innovation Strategy Award from AMBA, it has been awarded the FMA Innovation in Teaching Award!

fma inspiring guest

2021 FMA Innovation in Teaching Award

fma 1

The Financial Management Association International‘s (FMA) Innovation in Teaching Award was created to recognize inspiring educators, improve the quality and relevance of education in finance and spread successful innovative practices. This international competition is open to any educator who teaches undergraduate or graduate students in finance.

The finalists are selected by a committee based on 3 criterias:

  • Innovation
  • Broad transferability of the teaching technique in terms of resources and instructor skills/connections
  • Measurable impact on students, institutions of higher education, and the finance profession

David Stolin, co-founder of TBS Education’s Inspiring Guest program with Elie Gray, received the 1st prize for their project “Teaching finance through short humorous videos made in collaboration with a comedian”.

Injecting humor into teaching finance

TBS Education is constantly exploring unconventional teaching methods, favoring pedagogical innovation for the benefit of its students. The Business School offers a wide range of technics to acquire knowledge and prepare for the business world. By offering an innovative approach to teaching, we capture students’ attention, make the content more memorable and develop their agility.

The first edition of Inspiring Guest project is developed around educational videos staring the Californian comedian Sammy Obeid. Not only the stand-up comedian is the host of “100 Humans” on Netflix but he is also a UC Berkeley Math & Business graduate.

The success of this first edition exceeded the expectations of the pedagogical team. Fully satisfied with the outcome, the Business School is currently preparing a new exciting edition of TBS Inspiring Guest.

Discover TBS professor Louise Curran’s point of view on the effect of COVID-19 on international trade policies.

As COVID-19 has spread across the world it has had major impacts on supply chains. It is reasonable to assume that the impact on trade flows may be even greater than that for the GFC in 2009, where world trade fell by over 20%. Most of this is an entirely natural result of the closure of many production structures around the world. However, some trade impacts are the direct result of trade policy interventions by governments, which presage a more major and long-term impact from the current crisis. Discover more in the video below:

[Série – Face à la crise Covid-19] How will Covid-19 impact international trade policies ? from FNEGE MEDIAS on Vimeo.

Before giving fund managers credit for good work, check how much of it could have been done by a monkey.

Monkey Selfie David Slater

Photo: David Slater via Wikimedia Commons

Monkeys can surprise you. This photo of a crested black macaque is a selfie. Aside from photography, monkeys are reputed to be surprisingly good at picking stocks. In his now-classic 1973 book A Random Walk Down Wall Street, Princeton University professor Burton Malkiel wrote that “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.” In recent years, research showed that monkeys (or, more precisely, randomly-generated stock portfolios) significantly outperform the stock market over the long run.

Monkey portfolios generally outperform the market

What may seem to be monkeys’ great handicap – their utter lack of interest in publicly traded companies – turns out to work to their advantage when it comes to portfolio formation. The stock market index represents companies in proportion to their size and is therefore dominated by large and fast-growing firms. By contrast, randomly selecting stocks into a portfolio tends to allocate more money to smaller and less glamorous companies, as well as breaking the link between portfolio weight and recent performance. Over extended periods, this blindness to company characteristics is rewarded with better investment returns. (While the reasons for this are subject to debate, overvaluation of in-vogue stocks seems to be one plausible explanation.)

Active managers exploit the “Monkey Effect”

If being oblivious to what’s going on in the market is what it takes to beat it, then you may not need a professional stock picker to manage your money. Or at the very least, you shouldn’t give investment managers credit for “the monkey effect” in their performance. This is the basic premise of our recent research paper.

Our approach is simple. On average, the performance of randomly chosen portfolios over the market index is similar to that of a portfolio where all stocks are weighted equally. We therefore study the correlation between the performance of active fund managers’ investment portfolios and the spread between equal-weighted and market-weighted portfolios’ performance. This can tell us how much of a fund’s performance could be replicated by mechanically tilting its portfolio toward an equal-weighted one. Of course, we also control for a range of other factors that have been known to impact investment returns.

Our results are striking. The equal-weight tilt is common among more than one thousand US mutual funds seeking to beat the S&P500 market index, and its extent is a key factor in explaining fund performance. On average, the size of the tilt is equivalent to investing 20 to 30% of a fund in an equal-weighted portfolio. Recognizing this fact in performance evaluation lowers the average fund’s risk-adjusted performance by as much as 0.7% percent per year.

Isolating the “Monkey Effect” in manager performance

Why might actively managed portfolios have a tilt toward equal weights? There are two possible explanations. One is that fund managers do this intentionally as they are aware that portfolios with random or equal weights generally outperform the market. Another is that this tilt is an unintended byproduct of their investment process (for example, the hit-and-miss nature of stock analysts’ recommendations could be analogous to throwing darts). Regardless of the underlying cause, an investor can acquire an equal-weight tilt much more cheaply than delegating the task to an expensive active manager – it is enough to combine a passively managed index fund (which can have fees of as little as 0.02% per year) with an equally-weighted one (with fees of as little as 0.2% per year).

After a series of legal and public-opinion battles, the credit for the monkey selfie was deemed to belong to the photographer; he did, after all, go to the trouble of travelling to the jungle, befriending the monkey, and setting up the camera – all necessary steps for us to enjoy the surprising photo. But when you come across surprisingly good performance by active fund managers, think twice whether they should get the credit (and the fees). Hint: they shouldn’t if a monkey could do it.


The authors evaluated the investment performance of actively managed U.S. mutual funds benchmarked against the S&P500 market index over the 1980-2009 period. They focused on the performance evaluation impact of including the spread between equal-weighted and market-value-weighted portfolios’ returns alongside established factors commonly used to assess fund performance. The article, titled “The equal-weight tilt in managed portfolios”, was published in Economics Letters in June 2019.

[su_pullquote align=”right”]By David Stolin[/su_pullquote]

On March 31, 2005, Lehman Brothers chairman and CEO Dick Fuld was re-elected to the company’s board with 87.3% investor support. Four years later Mr. Fuld was ranked as “the worst CEO of all time” by Portfolio magazine, and widely described as having professional and personal qualities that contributed to Lehman’s collapse – and, due to Lehman’s position at the heart of the financial sector, to the international financial crisis.

We do not know how every Lehman shareholder voted in that election, much less the reasons for how they voted. We do know that around two-thirds of Lehman’s stock was held by other prominent financial institutions, the top ten being Citigroup, State Street, Barclays, Morgan Stanley Dean Witter, Vanguard, AXA, Fisher Investments, MFS, Mellon Bank, and Merrill Lynch. Most of these firms and their managers would be expected to have repeated dealings with Lehman and its management. As a result, we would expect these firms to be particularly well-informed about Mr. Fuld’s shortcomings and to have voiced concerns about his ongoing concentration of power.
On the other hand, the combination of Mr. Fuld’s shortcomings and his power made him a formidable enemy. He is on record as saying “I want to reach in, rip out their heart, and eat it, before they die” about his professional adversaries.

It is a stimulating thought exercise to visualize Mr. Fuld’s reaction upon learning that, say, Citigroup or Merrill Lynch had voted against his re-election to Lehman’s board. We note that at Lehman, like at the vast majority of U.S. firms, voting was not confidential. This means that Lehman’s management could find out how each of the company’s shareholders voted. And this would raise a problem for Lehman’s institutional investors: even if they disagree with the management, is it worth incurring the management’s wrath by voting against it?



Of course, it is natural for managers to be unhappy with shareholders who vote against them. But for at least three reasons, such feelings matter more when the investee company is in the financial sector.

• The first reason is the “old boys’ network”. Decision-makers at the investing firm are especially likely to be connected to their counterparts at the investee if both have finance backgrounds: they are more likely to have received the same education, to be active in the same professional organizations, to have worked at the same companies in their past careers, and to expect to do so in the future. This increases the potential for retaliation (or reciprocation) at the individual level.

• The second reason is firm-level interaction. Financial firms are more likely to have competitor or supplier/client relationships with their investors than do non-financial firms. This means that retaliation and reciprocation can be channeled through such relationships as well.

• The third reason is cross-holdings of shares. A financial firm may hold shares in its own institutional shareholder, which gives the firm another potential means of retaliating for any anti-management votes by that shareholder, namely, voting against the shareholder’s own management. Conversely, investor and investee may reciprocate by supporting each other through voting.

How can we examine if our suspicions are founded? The only group of institutions systematically required to disclose their votes is U.S. mutual funds, and accordingly we focus our study on mutual fund companies. Our empirical tests suggest that all three types of conflicts of interest listed above do matter. Social ties between the voting and target firms increase the voting firm’s support for the target’s management. In addition, voting appears to be influenced by the fear of retaliation, both in the form of being voted against in the future and of being aggressively competed against in the future. Our results suggest that there is “clubbiness” in the way fund companies vote on each other. We then go on to examine the implications of this clubbiness. We show that directors elected in fund companies with greater own-industry support, monitor senior management significantly less.

To generalize our findings, we then use aggregate voting outcomes to assess whether financial companies as a group vote more favorably when it comes to their financial sector peers and we find that this is the case as well.

In short, the financial sector’s inevitable and extensive investment in itself has a deleterious effect on its governance. What can be done about it? We believe that our work has at least two important policy implications.

First, the notion of conflicts of interest which institutional investors address in their voting policies should be explicitly defined to include not only client/supplier relationships, but also conflicts of interest through product market competition and reciprocal investments. Such recognition would help take voting out of the hands of individuals most inclined to vote in a conflicted manner, or at least constrain these individuals’ discretion.

Second, proxy voting should be required to be confidential at firms in the financial sector; i.e. investee firms should not be able to discover how different shareholders voted. This would mitigate a key reason for conflicted voting, which is potential retaliation/reciprocation by the investee’s management.

It would be naïve to think that decision-making in business can ever be rid of conflicts of interest. But in the case of proxy voting in financial firms, the problem is important enough to deserve a close look from regulators.

[su_spoiler title=”Méthodologie”]Afin d’enquêter sur les conflits d’intérêts entre les gestionnaires d’actifs, les auteurs ont étudié la procuration de votes des fonds communs de placement sur des propositions de gestion d’actifs. L’étude couvre la période 2004-2013 et les variables explicatives étaient les fonds, la société et la relation fonds-société. Ils ont également analysé les résultats des votes rattachés. L’étude a été publié en Mars 2017 en la version papier du Management Science Journal.[/su_spoiler]

[su_pullquote align=”right”]By Uche Okongwu[/su_pullquote]

Supply chain optimization essentially involves finding a compromise between striving for customer satisfaction at the same time as profitability. By adjusting the different supply-chain planning parameters, each company can achieve the performance level in line with its strategy and objectives.

The concept of the supply chain is as old as economics: from the supply of materials to production and delivery, the successive players involved in any given market represent the links in a chain, acting as customers and suppliers to each other respectively. However, increased competition and globalization have made companies realize that all the different players in their supply chain share a common goal, namely customer satisfaction. Consequently, how the supply chain is organized and how it performs are of crucial strategic importance for companies, and increasingly so. In this regard, the example of the aerospace industry is regularly covered in business news and highlights this strategic role perfectly; indeed, the industry has had to increase production rates to meet the growing demand and this has created tension throughout the chain. However, this problem actually concerns all sectors of the economy, whether in industry or in services. Over the last twenty years, researchers and managers have been looking at ways of optimizing supply-chain management to improve companies’ performances, based on the ideas of collaboration, integration and information sharing.

The difficulty in resolving this issue lies in the complexity of the supply chain itself; in addition to the number of links in the chain, we need to take into account the number of performance indicators and particularly the number of parameters that a company can adjust in order to meet its performance targets, which is infinite. Until now, the research had focused on one parameter or another, sometimes combining them, but in a limited way. For the first time, our study aims to go further by combining several parameters positioned at different stages and functions in the chain (planning, procurement, production, delivery), in order to establish which combination of key factors produces the best performance.

Performance: always a question of compromise

The first issue that needs to be addressed concerns the supply-chain performance, indicators. Many indicators are used, some of which are contradictory, since certain indicators are linked to profitability and others to customer satisfaction. For our study, we selected three: profit margin, on-time delivery and delivering the quantities requested. Ideally, an optimized supply chain should make it possible to achieve maximum scores on all these parameters, but in reality, no company can claim to be the best in every area. As such, you have to reach a compromise at some point, according to your market and objectives, by accepting to “sacrifice” part of your performance on a given indicator. With this in mind, the idea of optimum supply-chain performance depends on the objectives the company sets in terms of profitability and customer satisfaction, but also in relation to its position in the market. Consequently, the main challenge in supply chain planning is finding this compromise.

The case on which we worked was inspired by a real situation. It concerns a supply chain in the field of furniture, for the production of tables and shelves. Out of the 12 general supply-chain planning parameters we identified, we decided to alter six and to observe the result of the simulation on our performance criteria: the planning time-frame(short or long), the production capacity in terms of human resources (constant or adapted to the demand), the production sequencing (priority given to the oldest or the most recent orders), the duration of the cycle, the reliability of the forecasts and the availability or otherwise of stocks.

In the case of this supply chain, the production capacity appears to have a strong impact on margins and the ability to meet demand, whereas sequencing has a greater impact on the promptness of deliveries and the extent to which the response meets the demand.

Addressing the company’s priorities

These results confirm the initial hypothesis, namely that different combinations of planning parameters will have different impacts on the performance indicators. The different planning parameters cannot be considered independently of the performance criteria, hence the need to make choices. The ideal combination of parameters depends on the performance sought by the company.
Using the model developed in this study, managers responsible for supply-chain planning have a theoretical and practical tool to help them in their decision-making, allowing them to determine the best combination based on the company’s priorities. The framework and methodology developed, as well as the results obtained, are a genuine breakthrough in terms of research. To take things further, it would be interesting to combine even more parameters – as long as the computer-simulation tools available make this possible -, and to test the model on different supply chain structures and in other market environments.

[su_spoiler title=”Methodology”]To conduct this study, Uche Okongwu (TBS), Matthieu Lauras (TBS, Ecole des Mines Albi), Julien François and Jean-Christophe Deschamps (Bordeaux University) reviewed the available literature on the topic of supply-chain performance. Based on the following research question: “What combination of key factors in supply chain planning make it possible to optimize the performance of the supply chain?”, the authors developed equation models that they tested on a real supply-chain case in the furniture industry. The study was published in January 2016 in the Journal of Manufacturing Systems, in an article entitled: “Impact of the integration of tactical supply chain planning determinants on performance”.[/su_spoiler]

[su_note note_color=”#f8f8f8″]Uche Okongwu has been a Lecturer in Operations Management and Supply Chain Management at Toulouse Business School since 1991. He has combined his career as a researcher with that of an engineer and consultant in industrial organization. In 1990, he obtained a doctorate in Industrial Engineering at the Institut National Polytechnique de Lorraine (Nancy, France). He is currently Director of Educational Development and Innovation at TBS, having already set up the School’s industrial organization division [/su_note]

[su_pullquote align=”right”]By Lourdes Perez[/su_pullquote]

Contrary to conventional wisdom, small businesses are not condemned to be always at a disadvantage in their relations with large ones. They may have much to gain, provided they find a suitable mode of operation that avoids them finding themselves in competition when it comes to sharing the value created.

Under what conditions can both companies in a commercial partnership benefit fully and fairly? Until now, there has been something of a consensus on this issue: above all, the two companies in the partnership needed to be of equivalent size. As the profits from the partnership (development of new products, winning new markets, creation of additional income) are seen as a cake to be shared, they should be distributed according to the respective size and contributions of each partner. Seen from this point of view, an asymmetric partnership between a large company and an SME would most likely be less beneficial for the latter. Moreover, the literature on the subject generally stresses the risks for SMEs, which lack the weapons to defend themselves in this ‘coopetition’ relationship (cooperation-competition).

Complementarity rather than similarity

In opposition to this commonly-held idea, our study shows that on the contrary asymmetrical relationships offer opportunities for small businesses to innovate. This kind of relationship is virtually inevitable in the context of the globalized, ultra-competitive economy, where the most dangerous posture for a small company is to remain isolated. There are many examples of asymmetric partnerships, particularly in predominantly technological sectors, which have been found to be just as fruitful for “small” as for “large” companies. In many such cases, partners have been able to create relationships based on complementarity, which, in the end, is just as important as similarity.

This does not mean denying the risk of failure. The risk remains, but is far from insurmountable, as long as a strategy is devised to meet the challenges of this type of partnership: first, the difficulties of communication related to the differences in scale between the two structures (it’s rare for the head of an SME to have direct access to the Managing Director of a large company); and secondly, the differences in organizational structure and ways of working.

If the small business systematically approaches such a relationship with due respect for a number of basic rules, it increases the chance of a profitable outcome. To reach this conclusion, we analyzed a successful partnership between a small Spanish seafood company that wanted to extend the time it could conserve its shellfish and a large Italian company in the energy sector. From this case study, we developed a model that summarizes in three key steps the approach that a small business should follow to avoid the pitfalls generally associated with asymmetric partnerships.

Three basic steps

The first step requires the selection of only a small number of partners. An SME does not have the means to commit itself seriously to multiple partnerships with large companies because it lacks time, logistical organisation and resources. It therefore has every interest in building a lasting alliance with a partner whose strategic objectives are complementary to its own. In our case, the two companies had very different motivations for forming a relationship: whereas the SME sought a technological solution, the large company saw an opportunity to enter the Spanish market, in a sector where it was not previously present. There was therefore no question of sharing the profits of the partnership, as they were not the same for each partner.

The second step is the construction of a strong and committed relationship that offsets the imbalance between the two structures. This requires a serious commitment on the part of the SME, which must nominate a “champion” within the company, i.e. a privileged contact person, with sufficient clout in the organization, someone who is respected throughout the company and who is capable of defending the project and driving it forward in spite of any resistance and obstacles that may arise.

The third step is to develop proposals of mutual value. At the beginning of the partnership, the SME and the large company each pursue specific objectives. But once the project gets under way, some appear unattainable and others incompatible, while new ones appear. The important thing here is to find the appropriate balance between obstinacy and flexibility: to be able to hold firm to one’s positions while taking the partner and unforeseen events into account, and being prepared to rethink the initial objectives. This requires an ability to listen, an open mind, and knowing the partner, its objectives and its motivations.

100% benefit for each side

The success of this strategy clearly shows that there is no reason why an asymmetrical partnership should inevitably be less beneficial to the smaller partner. In our case study, each partner obtained 100% of what it was seeking, because they had expectations that were in no way mutually exclusive and because they were able to build their compatibility together. This new perception of asymmetry in a cooperative spirit, rather than as an unequal balance of power, opens new perspectives for the understanding and the management of relations between unequal partners.

[su_note note_color=”#f8f8f8″]References: Based on an interview with Lourdes Pérez and the article “Uneven Partners: managing the power balance”, Lourdes Pérez and Jesùs J. Cambra-Fierro, Journal of Business Strategy, 2015.[/su_note]

[su_spoiler title=”Methodology”]Lourdes Pérez and Jesús J. Cambra-Fierro undertook a qualitative case study of two companies, a Spanish SME and a large Italian company, engaged in an asymmetric partnership. The information collected was from a documentary survey (public information, sectoral information, databases) and a review of the scientific literature. Interviews with several qualified people in each company, based on open-ended questionnaires, helped the researchers determine the major themes of the study and build a matrix. The conclusions of the study are a synthesis of these different sources.[/su_spoiler]

[su_pullquote align=”right”]By Laurent Germain et Anne Vanhems
This article won the Prize of the French Finance Association 2014.

We took a close look at the personality of traders to try and understand better how speculative bubbles work and we noticed that some traders do not act rationally. However they are not the only ones who affect financial markets.

For each transaction, traders have to take into account many parameters: market trends, competitors’ strategies and the latest news. But sometimes the situation gets out of hand, and other less rational aspects influence their decisions.

Studying why people make decisions can explain certain events

In spite of their experience, individuals sometimes act in a biased way. We may thus observe disproportionate reactions, such as buying shares at a price that is much too high in relation to their intrinsic value. These are illogical decisions which trigger speculative bubbles and stock markets then crash when everyone wants to sell assets simultaneously and their value collapses.

While it is now acknowledged that some traders do not act rationally at a given time, we still find it difficult to imagine that this might also be true for market-makers. These market-makers are organizations (mostly investment banks), or people, who set the buy and sell prices of assets: they are said to ‘quote’ the buying and selling prices and thus set the value of the assets. However, it is possible to demonstrate that some of these market-makers also make the wrong decisions. The market-makers are considered to be more experienced and “battle-hardened”. They are paid to stay one step ahead and traders are trained to analyze their latest strategies. As they are key players, it was difficult to admit that these market-makers might act irrationally, by increasing prices until red lights started flashing, or, inversely, lowering the price of shares in a context of increasing demand.

In order to study the effect of this phenomenon, we separated the two main biases. The first bias, related to the degree of optimism, causes the broker to misread the market trend. Thus when clues are showing that a share is about to lose value, he may think that it will soon go up again. The second bias, related to the level of self-confidence, leads him to over-estimate his own skill. He may then cause the price of the share to vary a lot, thus making the market more volatile. Now, the higher the volatility, the bigger the gains and losses.

The effects of these biases on markets

We first observed that the biases of market-makers affect the depth and liquidity of the market. A deep market is one in which the price remains relatively stable A liquid market is a market in which prices are not set aggressively (there is then a lot of buying and re-selling).

For instance, an optimistic market maker may think that the information he received is more reliable than it actually is and consider that his judgment is less crucial for his decision. He will then tend to overestimate the price of the asset, and traders (who buy and re-sell) will decrease the number of their transactions. When this market maker is too confident of his assessment, he will quote the share less aggressively and thus increase the liquidity of the market.

The tulip bulb crisis was the first speculative bubble and remains an outstanding example of a frenzied financial market. In 1636-1637, some bulbs were sold at more than 15 times the annual salary of the horticulturist and the volumes exchanged on the markets were completely unrelated to the actual number of available bulbs.

The first conclusion we can draw from this study is that market-makers who are too confident or not confident enough can make either profits or losses. When the market maker is pessimistic, but still trusts his own judgment, then price variations are seen to be weaker.

Prices increase mechanically, and the volume exchanged by rational traders is then low. Nevertheless, one conclusion of the study is that market-makers are able to take advantage of this market: the rise in prices does not affect the overall demand.

The results of this research also show that while traders with biased behavior trigger situations of disequilibrium, market-makers who are over-confident increase the likelihood that this will happen. For instance, an optimistic market maker amplifies excessive trading, which means that there are too many transactions. We can compare this to the Internet bubble, when both traders and market-makers thought they were witnessing the birth of a new economy and hence the likelihood of extreme growth.

The prices of shares in technology start-ups then went sky-high, uncorrelated with the actual profits of the companies and nevertheless, the number of transactions continued to increase. The March 2000 crash led to a recession in the sector but also in the economy in general with losses exceeding the profits made.

Moreover, we proved that there was an unexpected result: the fact that market-makers may behave in a biased way sometimes favors traders who are not very confident. In this case, a trader who lacks confidence may get better results than a trader who acts correctly. Consider for example a share whose value will not change. The optimistic market maker believes that it will increase and therefore sets a high price. A pessimistic trader believes that it will drop and therefore sells his shares, whereas a ‘standard’ trader will wait. In this case the pessimistic trader will make profits but not the ‘standard’ trader.

We may conclude from our research that the volatility observed may not only be due to traders, but may also be amplified by the attitude of market-makers. In fact, the last conclusion of the study is that in the extreme cases of levels of confidence, we observe excessive volatility and an excessive number of transactions. In a situation in which some traders lack confidence, market-makers who also lack confidence will cause rational traders to make too many transactions.

We are now working on a new more complex model which assumes that some market-makers act according to the way others do: in other words they no longer act as independent ‘black boxes’ but take into account the strategies of their counterparts.

[su_note note_color=”#f8f8f8″]Reference: This article written by Laurent Germain and Anne Vanhems and the article entitled “Irrational Market-makers”, co-authored by Fabrice Rousseau and Anne Vanhems, were published in Finance vol. 35, no. 1, April 2014. This article won the Prize of the French Finance Association 2014.[/su_note]

[su_box title=”Practical applications” style=”soft” box_color=”#f8f8f8″ title_color=”#111111″]These unpublished results pave the way for new strategies in which traders and market-makers should consider that, both among their peers and their competitors, some agents may take biased decisions.

Banks expressed a lot of interest in the study when the article was published and we may assume that this theory has been integrated into their trading practices[/su_box]

[su_spoiler title=”Methodology “]Our team of researchers constructed a mathematical model simulating the effects of psychological biases on markets. We defined two reference scenarios: the first in which all actors are rational and a second including rational and irrational traders dealing with rational market-makers. This enabled us first to illustrate the impact of trader irrationality. We then compared these results to a simulation in which all of the market-makers are irrational.[/su_spoiler]

[su_pullquote align=”right”]By Sylvain Bourjade[/su_pullquote]

It is difficult to find experts that are both competent and independent. We show that in order to avoid conflicts of interest clouding expertise, the opinions and votes of each expert must be made public.

The Mediator scandal showed that conflicts of interest can have serious repercussions which may even lead to the deaths of several people. How can this be avoided while guaranteeing quality expert advice? Our research shows that it is possible to limit conflicts of interest by laying down rules for more transparency, but within limits.

It is always a challenge to find good experts: the most competent of them often have conflicts of interest. The researchers are partially financed by manufacturers with whom they sometimes are bound by consultancy contracts. This means that they may alter their opinion in order not to displease the manufacturers in question.

To minimize these conflicts of interest, without nevertheless having to rely on less qualified experts, we made a mathematical model of the behavior of the different parties. Experts are torn between three requirements: they may indeed have a biased opinion due to the conflict of interest, but they have at the same time to protect their reputation for impartiality so that they continue to be called upon as experts. Finally, even if they do have strong ties with industry they nevertheless continue to uphold certain principles. For example, they will refuse to approve a drug if they know it to be dangerous. We believe that experts’ choices are based on these three elements, namely loyalty to a customer, the need to protect their reputation for impartiality and the need to uphold their moral principles.

Damaging opacity

In France, in most of the consultative agencies such as the National agency for safety of medicines and health products (ANSM- l’Agence Nationale de Sécurité du Médicament et des Produits de Santé), which was called Afssaps until 2012, neither the experts’ reports nor their votes are divulged. If an expert wishes to have a potentially dangerous drug approved for marketing, his reputation is not affected, since nobody knows the role that he has played in this decision. Opacity thus tends to favor poor decisions which may endanger the health of consumers (by for instance approving the marketing of a potentially toxic drug) due to conflicts of interest.

Conversely, any transparency which is based on the reputation of experts, improves the expert advice. This is the case when their identity and the content of the report as well as their votes are known. In this case, the expert can no longer hide behind the argument “It was the committee that decided “. In the United States, the Food and Drug Administration (FDA), which is responsible for approving drugs for the American market, thus decided to improve its expert advice rules in order to limit conflicts of interest. The experts now pronounce their opinion simultaneously and the FDA reveals how each expert voted and publishes a detailed report of each meeting.

Protecting one’s reputation

The first results of this theoretical study are in no way surprising as the positive effects of transparency are well-known. But our research has spotlighted more astonishing effects in which transparency, on the contrary, has a negative effect on the quality of decisions taken by expert committees, leading for instance to the approval of dangerous substances. This is because, when the expert’s conflicts of interest are well-known, everyone expects him to come out in favor of the manufacturers that finance him. This means there is no danger that his reports and votes will damage his reputation, since it is already “bad” due to the fact that he has revealed his links with these manufacturers.

Conversely, if he does not reveal his conflicts of interest, the expert will be inclined to vote against the manufacturers’ proposals in order to protect his reputation. Hence, according to the model we developed, the decisions will be improved if the reports and decisions of experts are divulged, but not necessarily their links with manufacturers. The rules should also encourage them to be honest: experts who have taken dangerous decisions should no longer be consulted. When decisions are to be taken, the way in which the consultative procedure is set up is crucial: it is particularly important to know each expert’s opinion and the way in which he voted.

Endocrine disruptors and climatology

It is still difficult to prove beyond doubt that the quality of expert advice is improved when transparency rules are applied. This cannot be observed since the quality of the decision can only be judged after a long time. To determine whether the new rules of the Food and Drug Administration are successful, we shall have to analyze the results in 10 years’ time. Nevertheless it is clear that more transparency will be helpful for French and European health and safety agencies, especially given the many health issues under discussion.

This is the case in particular for “endocrine disruptors”, compounds which interfere with our hormone system (including the notorious Bisphenol-A, which is now prohibited in food containers). Several scientific studies have proven the dangers of these chemical substances, but they are still widely used by manufacturers. The decisions of the European Food Safety Authority (EFSA) concerning endocrine disruptors, have been severely criticized by scientists, who accuse EFSA of being too sensitive to lobbies and conflicts of interest and of having opaque expert-advice rules. Conversely, in climatology, the Intergovernmental Panel on Climate Change (IPCC), whose reports are widely recognized by scientists, has particularly strong transparency rules.

[su_note note_color=”#f8f8f8″]By Sylvain Bourjade and the article “The roles of reputation and transparency on the behavior of biased experts” published with Bruno Jullien in the RAND Journal of Economics, Vol. 42, No. 3, 2011.[/su_note]

[su_box title=”Practical applications” style=”soft” box_color=”#f8f8f8″ title_color=”#111111″]The model we have developed applies both to drug agencies and other fields in which expertise is required but risks being biased by conflicts of interest. This is the case for instance for anti-monopoly policy, for which experts have to decide whether to entities may merge even though the experts in question may have links with these entities or with their competitors. It is also the case for recommendations made by financial analysts. Even more surprising is that this work also applies to peer reviews of scientific work in which scientific articles are judged by other researchers whose names remain secret.[/su_box]

[su_spoiler title=”Methodology”]The work done by Bruno Jullien is a theoretical study in a field of mathematics called “game theory”. It involves modelling the behaviour of experts by estimating which elements predominated in their decisions. That depends on the short and long-term objectives of the experts. The study is not based on expertise data, since it is not available for the moment.[/su_spoiler]