The world can certainly be moved by a powerful idea. But even the best ideas need to be nurtured and strengthened through feedback and critique so that they might survive being debated, pulled apart and put back together, tested through the rigorous standard Chicago intellectual output. That’s the dirty work of scholarship, and it often takes place during conferences like the Chicago Initiative in Theory and Empirics (CITE), now in its second year of providing a trusted venue for new ideas and approaches for analyzing problems at the intersection of finance and macroeconomics.
Bryan Kelly, an associate professor of finance for the University of Chicago Booth School of Business, says that the place in which new research can start differs hugely to what the final idea will look like when shared widely with peers, and eventually the public. “It’s closer to a skeleton of an idea,” says Kelly. “You have an idea for an argument, or some facts or economic mechanism that might be interesting, but you haven’t fleshed out all of the support for it.” If a novel approach to, say, modeling asset prices is going to be useful to policymakers, regulators, or the business community, it needs to stand up the scrutiny of peer review and the brutality of a Chicago workshop, the amount of data and argumentative support for it must be immense. Part of building that evidence is workshopping the new ideas within a trusted circle of scholars.
CITE represents one such circle, with attendees and presenters that have collaborated together repeatedly in faculty roles, as well as early on as former students of Lars Peter Hansen, Monika Piazzesi, and Martin Schneider.”Most of the people at this conference are people that have known each other and interacted with one another for a long time,” says Kelly. “If you set up the guidelines early——that it’s early stage and we’re here to give each other constructive feedback——then that’s how it will go.”
Kelly himself presented work on a mechanism he and his coauthors believe is having an impact on asset prices. He has the evidence to support the idea, but the paper is a long way from complete. “We haven’t fully formulated the story we have in mind yet,” explained Kelly.
About half of the work presented at CITE took the form of new research in need of early feedback. The mix of top minds in the fields of asset pricing, monetary policy, financial modeling and macroeconomic linkages makes for a fertile environment to grow new ideas into big ones.
A high-powered early stage conference like CITE also creates an environment for presenting work at the absolute bleeding edge. For instance: how do we build models to predict the choices of agents that aren’t sure if they have the right model of understanding the world around them? These “robust choice under uncertainty” problems were at the heart of work presented by Jaroslav Borovička and Lars Peter Hansen. “They were trying to put the pieces in place for formulating the problem,” recounted Kelly. “And then they had some preliminary solutions, which they talked about [with the group].”
Typically, models assume their constituent agents have perfect knowledge of the world and will act on it rationally, but of course, that’s not how the real world works. The thrust of what Borovička and Hansen seek to model and explain is how beliefs and information get distorted by uncertainty, reconciling choices that don’t fit conventional models with the real world. “That’s a very non-traditional way of thinking about economic agents—usually we give them superhuman powers!” says Kelly. Borovička proposed trying to rationalize belief distortions by uncertainty aversion or robust choice models. Hansen ran down the different families of models to explain how misspecifying a model might over or underestimate the degree to which uncertainty can shake a person’s decisions.
Kelly argues that you have to have people in the room willing to take on the hard problems in order to move the entire profession forward, and sometimes that requires some initial hashing out of ideas, concepts and approaches. “You need high powered folks like Jarda and Lars to solve the more complicated problems—they’re kind of at the frontier.”
Expanding the frontiers of financial modeling was very much a theme among CITE’s presenters. More than half were presenting work related to financial intermediaries—investment banks, institutional investors, and the like—and how their large footprint in the marketplace is shaping asset prices.
“It deviates from the long history of asset pricing in economics where you think about households,” explains Kelly. In decades of study, classic models of households optimizing their consumption and making investments to save for the future simply does not reconcile with observed asset prices in the real world. One alternative model? That households don’t have the resources to trade in everything on their own. “People have jobs, they only have so much attention that they can allocate to trading. They don’t have the expertise. Who does? Investment banks.”
An intermediary arises to bridge this friction between the marketplace and the household, enabling them to trade assets that might otherwise be unavailable. “There’s a class of models that helps us understand what the asset pricing looks like with that friction in place,” says Kelly.
Building out more complex and connected asset pricing models in this way dovetails with monetary policy, since a large degree of intermediary transactions come via the banking system. Scholarship on monetary policy and its linkages to the broader financial marketplace occupied the rest of the CITE schedule, including a model from Monika Piazzesi and Martin Schneider linking the payments system and securities markets, allowing for beliefs about asset payoffs to matter for the money supply and the price level, and monetary policy matters for real asset values.
Making those connections between wildly varying pieces of the financial system is complex and messy work. But getting people in a room to talk out early ideas of how the puzzles fit together is a critical step forward toward building enduring scholarship. Ultimately, conversations at CITE and beyond could shape a bigger, more holistic understanding of how the pieces of our financial system fit together.
—Mark Riechers