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The lowdown


How data on short selling can help prevent financial crisis

During the financial crisis some bankers crossed the line. Pedro Saffi, University Lecturer in Finance, says data could help us make sure they don’t make the same mistakes again.

Numbers: short selling
In 2008, Pedro Saffi, now University Lecturer in Finance at Cambridge Judge Business School, watched along with everyone else as financial markets crashed. But he can at least use lessons from that financial crisis to help prevent the next one. A specialist in short selling and liquidity in the equity markets – and with access to a cache of corporate data on short selling – Saffi is in a unique position to get under the skin of how transactions reflected what was happening.

Dr Pedro Saffi

Dr Pedro Saffi

“Bankers try to maximise profits without breaking the law but just before and during the crisis many of them crossed over the line.” he says. Eight years – and a lot of analysis – later, he says that he remains relatively pessimistic about the financial future. “A lot of mistakes have been made, but at the same time a lot of people have been protected personally from the impact of those mistakes. It remains a game of cops and robbers, and I’m not sure who’s winning.”

But Pedro says data can now plan an important role in monitoring and enforcement.

“We now have access to data on short selling over a long period of time. This gives us insights that policymakers and regulators simply didn’t have previously about what goes on behind the scenes in stock markets,” he says. “This can help detect movements that may result in stress and future crisis, so analysis of this sort of data could serve as a leading indicator of systemic problems going forward.”

He is reconciled to the fact that “things don’t always work out as we might expect” but worries that academic papers are becoming narrower in their areas of interest and aren’t reaching the wider audience. “Fewer people than you might expect have seen the research on short selling”.

Saffi’s own work in this area includes research that shows that the structure – and not just the per cent – of institutional ownership is important in understanding limits to arbitrage. Another research paper shows that stocks with a high degree of short selling activity experience large positive returns and a reduction in short selling activity around periods of funding capital scarcity; that paper, entitled “Deleveraging risk,” recently won third-place honours at the annual Crowell Prize awards sponsored by the Quantitative Research Group at PanAgora Asset Management.

Today, Saffi works hard to ensure his students are prepared for corporate and financial life. He recognises the challenges, because as an undergraduate in Rio de Janeiro, Saffi had his own dreams of becoming a millionaire banker, a factor that led him to take his father’s advice and study economics rather than his then passion, genetic engineering. “He pointed out that a career in biology might be difficult in Brazil, though working in Cambridge I’m not so sure now!” But Saffi soon realised that he was happier in an academic environment. “I may earn less than an investment banker” but “I have flexibility, which for me is essential.”

What Saffi really likes is to travel. Brazilian and Italian by nationality, he taught at the Fundaçăo Getulio Vargas in Brazil, Reykjavik University in Iceland, the Nile University in Egypt and the IESE Business School in Barcelona before coming to Cambridge. At the South Korean embassy in London to get a visa for his next teaching expedition, he counted up the number of countries he had visited over the last five years and was pleased to come to a total of 17. “I love meeting interesting people around the world. Having a profession which I enjoy completely and which allows me to travel – I just love it”.

Travel has another benefit: it enriches his teaching. “The point of view of a Scandinavian student to a Brazilian to an Egyptian student is totally different. Which is why I become frustrated at the banks’ recruiting policies. If you look around, the banks still tend to employ the same type of person, your typical white male from the top business schools. We really must try harder to improve diversity. A lot of people who all think alike is not a good thing. We’ve seen what can happen if everyone follows the crowd. Things are slowly improving but it is hard to change old habits. ”

Saffi is also serious about engagement: ensuring that his research has real-world impact. “We have to find more ways to reconcile academic theory with what happens in the actual world of finance.” A self-confessed geek who is into sci-fi and video gaming, Saffi has always been engrossed in the empirical side of research. He hopes his analysis of the statistics around the good and bad impacts of short selling and the structure of financial markets will help provide guidance around new legislation and its implementation.

Indeed, he believes that in order to be useful, academics need to remain unbiased in their dealings with the financial world. “It is important to me as an academic to be able to analyse the data and draw my own conclusions without having an agenda forced upon me. Which is probably why in the end I wouldn’t have made a good banker.” He may be interested in money but it doesn’t drive him. Instead, he’s off next to take surfing lessons in Portugal – learning to live life on the ocean wave rather than the rollercoaster of the financial markets.