RiskMinds - from Blame to Bubble Indices...

I am attending the RiskMinds Conference in Geneva this week. Given what has happened over the past year, its somewhat intellectual name seems less appropriate than it once did, but I guess not many of us are smelling of roses on that point...

Seems to be very good attendance with the main hall full to overflowing for the first full day of the conference - unsurprisingly I think many people are looking for answers (from "what did I do wrong?" to "who can I blame?"). From a quick survey of the attendees, there seems to be no doubt that regulators and the credit rating agencies seem to be the favoured candidates to blame.

Robert Shiller (author of Irrational Exuberance) gave the openning talk on the current credit crisis and what to do about it. He made the point that behavioural finance (stock market pyschology) is becoming much more integrated with financial markets theory, and put forward the positive point that financial theory needs to be expanded to encompass what we have experienced over the past year, not that all financial theory should be thrown away (a jibe at Taleb on this point?)

Much of Professor Shiller's talk was spent on illustrating various "bubbles" in real asset prices in various markets against long run trends, usually involving a comparison with the data of the Great Depression of the 1930's, and an occaisional mention of his book (I haven't read it (yet) but I would guess it spends a lot of time on bubbles too). He is very keen on the democratisation of finance, more particularly of financial advice (it would seem that the FSA has been listening in the UK, with the recent action against commission-based financial advisors).

He also proposes greater usage of macro economic indices and related derivatives to make risks of house price falls, inflation, economic growth, employment etc more transparent to all and to allow easier hedging of these risks. He raised some eye-brows of many banking staff by proposing mortgages whose payments went down when these factors moved against a house owner (with the originator hedging these risks using futures on the indices he proposes). He was not so clear what should happen when these factors went in favour of the house owner!

One thought struck me though the talk, is that if it is relatively easy to illustrate/calculate these real asset price bubbles illustrated by Professor Shiller, then why not go further than just having indices on direct macro-economic variables and have indices based on these "bubble" calculations? If everyone could see that the "bubble" index for a particular risk factor was high then you could hedge your "irrational exuberance" or at the very least there would be a transparent indicator that a market was moving into dangerous price territory. Stupid idea? Maybe, but if it has legs please remember you heard the nickname"Aero" for the cocoa index here first!...