How will the Chair’s research programme make a step change in existing research?
The Chair’s research programme will seek to make a step change in existing research by innovating in FOUR main ways:
1. Mega trends – our research is based on the recognition that a paradigm change is needed in order to engage with global financial issues that result from far reaching structural changes in the world’s financial and economic systems. Analysing those changes, with the scientific name mega trends, is an important part of our research programme. In it we create a unique database identifying them, measuring them, specifying points in their time paths and regional divergences, and analysing their drivers and their effects on global finance, resilience and growth. Identifying and analysing mega trends requires a long-term research programme as by their nature megatrends have lasting effects that can need to be tracked and evaluated over a 10-30 year time period. For example the economic reforms in China that began in 1978 are still being felt in the world economy today via the recent emergence of China as the world’s second largest economy. Similarly the effects of rise in the sub-prime mortgage market and asset based derivatives 10-15 years ago is still being affecting financial flows, financial regulation and growth. The internationalisation of the RMB, the rise of bitcoin, new financial instruments, new patterns of trade and investment associated with rapid growth in some African countries will all have lasting impacts on the international financial system over the medium to long term. Identifying, and quantifying megatrends is important so that we can assess their effects on the international financial system and on economic growth and design suitable policy measures. This element of the proposed research will provide information on mega trends that is distinct from, but has parallels with the work on medium term business cycles established in the twentieth century by the National Bureau of Economic Research in the US. While there are some Research Centres for Finance already in existence, none is concerned with analysing mega trends, incorporating new trends into theory and building a comprehensive data base for use in theoretical and empirical research, which is the concern of this proposed research programme.
2. The identification and measurement of mega trends will allow us to introduce dynamics in the widely used static flow of funds framework to allow for the time dimension during which the system of accounts evolves for all financial transactions that have a global link. By conducting stochastic simulations on a dynamic flow of funds model, it is possible to explore feasible scenarios and trends, based on probability of uncertainly.
3. Use of meta-analysis and synthetic reviews to reconcile findings and disagreements and generate strategic information for positioning policy and practice as well as guiding further research in the key areas where global trends tend to happen. For example, China’s investment behaviour globally, capital flows both private and public, financial innovation, financial contagion, cross-border banking, among other trends in the recent past.
4. Use of field experiments (random control trials) to study the effects of financial products (such as crop insurance), involving households, private sector companies and banks.
How will the AXA Chair contribute to creating new knowledge?
The research by the AXA Chair in Global Finance will use the flow-of-funds framework to construct a large database for econometric work (estimation, simulation and forecasting) in order to identify and monitor mega trends in global finance, allowing for dynamics of competitive conditions (among households, firms, banks, and governments), which are engendered by the interplay between institutional economics and technological innovations.
We conceptualise mega trends as clear, persistent and long-term trajectories which dominate and influence many other financial outcomes; a historical example is the sharp rise in petrol prices in the 1970s that led to the recycling of petro-dollars, followed by the debt crisis in the 1980s. In our scientific program, identified mega trends will provide an input into the process of building theory and specification of econometric models. Hence, the step change in our scientific work involves: the construction of large flow of funds datasets; identification and analysis of mega trends; internalising the permeating power of uncertainty as well as the mega trends in dynamic models; the explicit incorporation of non-price factors especially the endogenous role of government in models of regulation; and non-linearity and configuration of thresholds in modelling key finance metrics.
The use of large datasets to measure, monitor, and disseminate the mega global and regional trends that are fundamentally shaping the rules and practice of global finance and risk management, will generate new information to influence theory building to capture endogenous government role and to internalize uncertainty at the household level, company level, government level and foreign sector. Examples of fundamental origins of mega trends, which pose global risks, include:
(i) China’s impact as a global investor: the new context of China (and India), setting “new norms” in transforming the behaviour of financial markets, financial institutions, financial instruments, manufacturing and commerce. How is Chinese outbound investment influencing industries abroad or shaping trade in Africa? The big world picture is shifting, including the setting of new rules for global finance. What does this mean for the UK, EU and the USA? How can corporate leaders ensure their companies will thrive in a new global context? What are the effects of financial disintermediation in China and other emerging economies?
(ii) Technology-based financial innovation: Electronic money (such as BITCOIN and its potential successors) and currency wars. Also, how will the growth of non-traditional financial vehicles, including peer-to-peer lending, mobile payments systems and mobile financial services (such as those developing from the MPESA model) affect the theory and practice of finance and financial system stability? In this digital age, with such FinTech innovations, how can populations confront income and wealth inequality, investing in education and work-based training, and addressing vulnerable employment? These recently developed technologies and financial services may herald a shift towards disintermediation that leads to the decline of traditional banks and financial institutions, but may lead to new forms of intermediation through organically growing new financial institutions or through emulation and incorporation by established financial firms. And, as with any innovation, they generate new risks including systemic risks. Our research programme analyses those possible changes and their effects.
(iii) New wave of political risk: These risks are unconventional and mutative, posing threats to global business and finance. The global security context has serious implications for global investment; the question is whether financial markets are mispricing geopolitical risks.
(iv) Investment uncertainty and new rules for the regulation of global finance arising from opaque rules for governing global finance, as in Basel III. For example, how are regulatory changes, technological and business model innovation reshaping the global banking landscape? How can long-term investments be prioritized in the face of high volatility, uncertainty and complexity?
(v) Islamic finance: different rules of the game? The growth of alternative forms of banking and finance, such as Islamic Banking and Finance. To what extent is the recent expansion of ‘Islamic’ finance sustainable (particularly in the context of financial developments in Africa and the Middle East)? And, while currently insignificant on a global scale, what are its potential effects on global finance? Will it be forever a niche market because of its inability to develop financial derivatives and other efficient risk and liquidity management tools? Or will there be increased convergence with ‘conventional’ banking and finance as regulators and markets promote lower leverage ratios in the latter and create a conventional system which has features closer to equity based Islamic finance. Other ‘alternative’ forms of finance such as crowd funding, and peer-to-peer lending, and their effects on global finance and risk, are examined under mega trend (i) above.
A cross-cutting element in all of the above is the fundamental assumption, in existing theoretical and empirical research that the financial system acts as the “brain” of an economy. It is assumed that the financial system promotes the dissemination and co-ordination of information about resource availability at every level throughout the economy, evaluates and prices inherent risk, and so enables the efficient allocation of these resources for supporting economic growth at national and global levels.
In terms of scientific methodology, the research program of the AXA Professor of Global Finance and the research at the Centre for Global Finance will involve building new theories, testing them using econometric techniques, and using simulation experiments to generate policy options or management scenarios. For example, the research in the above work-streams will use a wide range of data sources including: meta-analysis of existing research; compilation of new datasets based on existing primary sources; case-study; collection of new data using survey methods; randomised control trials; and existing secondary sources supplemented, as needed, by primary data collection. Likewise a range of methods will be used to analyse the data; selected to be appropriate to the problem in hand. Some studies will call for econometric methods for analysing time series, cross-section or panel data. Others will involve survey research methods, or more qualitative approaches including interviews and focus groups. We will also undertake some field experiments and develop new financial products for inclusive growth.
The research programme has a global perspective, but there will be some considerable focus on LICs in Africa, China, UK, Europe and the USA. The target audience for the findings will include: financial institutions and companies involved in monitoring trends in global finance and risk; policy makers in LICs, NGOs and the donor agencies; practitioners in finance ministries, central banks and other regulatory agencies; and researchers and academics.