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Paper on subprime ‘irrationality’ wins Cambridge-McKinsey Risk Prize

Winning paper by PhD candidate Rasheed Saleuddin finds ‘mark to market’ was not the culprit for the deepening financial crisis.2016_news_riskprize_883x432

The Cambridge Centre for Risk Studies at Cambridge Judge Business School, University of Cambridge announced on 21 June that Rasheed Saleuddin, a PhD candidate in History at the University of Cambridge, has won the annual Cambridge-McKinsey Risk Prize for his paper “Should credit risks be marked to market in crisis? Re-examining subprime securities ‘irrationality’ 2008-2010”.

Winning author Rasheed Saleuddin is also a scholar with Cambridge Endowment for Research in Finance, and is a portfolio manager with West Face Capital, managing a dedicated structured securities fund.

2016-06-21_news_riskprizewinners_229x205Honourable mentions went to two degree candidates at Cambridge Judge Business School: MBA student Simone Goldstein and Master of Finance (MFin) student Vladislav Mikhailov.

The prizes were announced at the School during the Cambridge Centre for Risk Studies 7th Risk Summit, by Dr Sven Heiligtag, Principal, McKinsey & Company.

The winning paper re-examines and challenges the contentions of some market observers and policymakers at the time of the financial crisis of 2008-2010 that the “mark to market” of residential mortgage-backed securities positions based on the observed prices of ABX indices may have exacerbated the crisis by forcing investors to sell such assets to shore up capital – because such indices overshot their fundamental value on the downside.

But the paper found that the prices of the ABX indices were reasonably determined based on market fundamentals at the time, so there was no reason not to mark to market. The research concluded that the problems related to over-leveraging, not mark to market.

“Blaming ABX for deepening the crisis may be akin to blaming the meteorologist for the weather,” the winning paper says. “The TV weather forecast is not always correct, and sometimes is horribly wrong. But it is not generally irrational, and we ignore forecasts at our peril… It is only in hindsight that signs of irrationality might be said to have entered ABX pricing.”

This was the first time that the Cambridge-McKinsey Prize has been open to University of Cambridge faculties beyond Cambridge Judge Business School. The Academic Director of the Centre for Risk Studies, Professor Daniel Ralph, said the results of doing so had been so successful that the catchment would be further broadened next year. “Insight into risk can come from many disciplines,” he said.