Partnership Princeton University and EDHEC-Risk Institute - an interview with Lionel Martellini

Written on 13 May 2013.

Lionel Martellini

The second edition of the EDHEC-Princeton conference "Academia Meets Practice" was held on April 3, 2013 in New York. What conclusions may be drawn from the event?
The broad ambition of EDHEC and Princeton faculty is not only to develop joint cutting-edge research in financial engineering, but also to make sure that the investment industry will benefit from whatever useful academic insights will be generated through these research efforts. It is in this context that we have organized the second edition of the EDHEC-Princeton “Academia Meets Practice” conference, which took place at the Princeton Club in New-York City on April 3rd 2013. On that occasion, speakers from EDHEC-Risk Institute, and from both the Economics and Operations Research and Financial Engineering (ORFE) department at Princeton University have provided more than 150 senior investment professionals with the latest academic insights related to new frontiers in institutional money management. The format of the conference was meant to facilitate the exchanges of views between academicians and practitioners in that it involved presentations by a member of the faculty of Princeton University or EDHEC-Risk Institute, followed by a discussion with the audience.

The unifying theme for this conference was the benefits in risk management in investment management. After some introductory comments, I have started in the morning with a presentation on the shift of focus away from asset classes to risk factors when designing a policy portfolio, and analyzing whether an improved understanding of diversification can help us generate improved risk-adjusted performance from an out-of-sample perspective. Then Professor Harisson Hong from the economics department at Princeton University has talked about "speculative betas", trying to help us understand the fascinating empirical puzzle stating that high risk stocks seem to have lower, as opposed to higher, returns. Professor John Mulvey from the ORFE department at Princeton University has followed up with an in-depth analysis of the benefits of dynamic strategies for tail risk hedging, with an emphasis on how dynamic long-short investment strategies, as opposed to static long-only strategies, are critically needed to extract risk premia on commodity markets. In the afternoon, the focus was on advanced risk analysis techniques for alternative asset classes such as hedge funds with Professor René Garcia from EDHEC Risk Institute, currencies with Professor Jakub Jurek from Princeton economics department, and finally private equity with Professor Florencio Lopez de Silanes from EDHEC-Risk Institute. Finally, Professor Frank Fabozzi from EDHEC-Risk Institute has provided some concluding comments about latest trends in asset management and how academic research can potentially be useful in helping reshape this industry.

Overall, the main conclusion from the conference presentations and the discussions that have followed is that risk management, defined as the art and science of spending investors' risk budgets in an astute way so as to generate the highest probability for them to reach their long-term investment/consumption objectives, is the key source of added value inn investment management.

The partnership between EDHEC-Risk and Princeton will soon be celebrating its first anniversary. What have been the results of this collaboration over the year?
I have spent the 2011-2012 academic year in the US, with the objective to assess how to best foster the development of EDHEC-Risk Institute influence in North-America in the years ahead. So as to benefit from a productive academic research environment while in the US, I have accepted a visiting faculty position at Princeton, in the ORFE department, where I had long been entertaining research discussions with Professor Mulvey, one of the leading experts in stochastic optimization in asset-liability management. Frank Fabozzi, who had just been hired as a full professor at EDHEC Business School, and who is located near Princeton where he has long-term ties with the finance faculty, has also been taking on a visiting position at Princeton, which has been renewed for the 2012-2013 academic year. From fruitful exchanges with Princeton faculty in the field of finance was initiated the partnership between the two institutions.

In addition to the second edition of our joint conference, the collaboration between EDHEC-Risk and Princeton has given rise to an ambitious research project on the statistical analysis of the dynamic information contained in the cross-sectional distributions of realized returns. This research effort is being led by Professor René Garcia and myself on EDHEC-Risk side, and by Professor Fan on Princeton side, with the involvement of Jiawei Wei, a PhD student at Princeton ORFE department with strong skills in financial econometrics.

Following-up on a recent paper (Garcia, Mantilla and Martellini (2013)), forthcoming in the Journal of Financial and Quantitative Analysis, which has demonstrated that the cross-sectional dispersion of equity returns on any given date could be regarded as a proxy for average idiosyncratic volatility, our ambition is now to test whether robust estimates for the the quantiles of the cross-sectional distribution of equity returns can be useful for predicting future aggregate equity returns and equity volatility.

What can we expect from this partnership in the future?
One of the key ambitions of this partnership is to develop innovative academic research in finance that could have a strong influence on the practice of investment management, at a time when the industry is facing a number of key paradigm changes leading to an increased focus on risk management. These developments also question a number of fundamental insights from modern portfolio theory, including for example the risk-return relationship from the cross-sectional and time-series perspectives, and the proposed joint research agenda is expected to address some questions that are not only practically relevant, but also on the forefront of outstanding problems in financial economics.

In the end, the common ambition of EDHEC-Risk Institute and Princeton ORFE is to jointly develop and manage a research program related to risk and investment management, and more precisely with a focus on improving risk management techniques regarded as the true source of added-value in investment management.

More specifically, the research program is expected to focus on the following two aspects: improved measures and models for risk indicators, and advanced uses of the risk indicators in risk management, portfolio decisions and regulatory guidance. These various research directions will heavily draw on tools borrowed from various academic fields, including in particular financial econometrics, mathematical finance and stochastic optimization. Princeton ORFE and EDHEC-Risk Institute faculties include some of the leading experts in these fields and their combined expertise is expected to lead to influential developments which would re-enforce the visibility of the two partnering institutions, both in academia and investment practice. In the Spring of 2014, we will hopefully be in a position to provide investment professionals with new insights on these questions on the occasion of the third "EDHEC-Princeton Academia Meets Practice" institutional money management conference.

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