How does performativity happen? The case of risk management…

March 26, 2007

Tomorrow Tuesday, Yuval Millo will be giving a talk at Columbia about performativity in the context of risk management. The title is “Mechanics of Performativity: How financial risk management made itself irrelevant”. (the most recent version of the paper)

Here’s the abstract:

The paper analyses the development of organised markets for the trading of stock options and focuses on the role that risk management techniques played in the evolution of these markets. The paper’s main claim is that financial risk management turned into a boundary object in options markets – a set of instructions and practices that served as a common ground and as a basis for discussion and operation. Using empirical data collected from primary documents and interviews, the paper argues that the remarkable success of today’s financial risk management should be attributed largely to the communicative and organisational aspects of the procedures and not necessarily to their accuracy or validity. The historical narrative presented in the paper, spanning from the late 1960s to the early 1990s, reveals the social, political and organisational factors that underpinned the exponential success of a particular mathematical tool, the Black-Scholes options pricing model. The intertwined trends and events that accompanied the growth of options markets – the transformation of margin calculation, emergence of index-based contracts and the dominance of institutional investors in the markets – increased the dependency of the various market participants (traders, exchanges’ staff and regulators) on mathematical risk management. The strength of financial risk management as a boundary object was tested in the early 1990s, when it was adopted by the SEC, in spite of the fact that under extreme market conditions (October 1987) the system produced unreliable calculations.

The talk will take place on Tuesday March 27th at 4.00 pm at room 802 of the International Affairs Building, at Columbia. It is part of the Heterarchy Seminar, and sponsored by the Center on Organizational Innovation.

2 Responses to “How does performativity happen? The case of risk management…”

  1. Peter Says:

    I had a few more thoughts about this paper, having re-read it in light of Fabian’s upcoming talk. I think one of the challenges might be to push performativity out of the pits, as it were. That is, the argument makes more sense to me in its more localized form than when it gets scoped upwards to the politics of BSM as risk management communicative device. I find it harder to get this fractal notion of performativity than to see how it works at the level of traders, and even firms.

    The second thing, I’m struck again at the clever way that BSM goes from being valued-as-truth to being valued-as-communicative-device. As I said then, I would have used the concept of commensuration, but it’s the same idea – that vol becomes the de facto way to speak about widely ranging investment strategies and products.

    Incidentally, I was reading James March’s Primer on Decision Making, and I was struck by his brief (pps.35-55) but very provocative discussion of risk. In particular he notes most people’s inability to distinguish very small risks from no risk, and the organizational effects of this. It strikes me, for instance, that there really is no such thing as a risk-free portfolio against which to baseline everything else. That this has come to loom so large in contemp finance, and that it is a flawed assumption, seems relevant in an interesting way..

  2. Yuval Says:

    Thanks again for your insightful comments at the talk. Here, however, I think that you’ve got a false dichotomy. That is, there is no real distinction between decision making and communication. Traders, right from the word ‘go’, as it were, use model-based applications as “risk management communicative devices”. Making a trade includes justifying it to oneself, to one’s colleagues, and in putting into a more general sense-making framework. This, in effect, brings us back to what we, as economic sociologists, try to show: that market participants do not behave in an atomistic manner and that they interact continuously.

    Your comment about James March and the impossibility of having, in practice, a risk-free portfolio is very intriguing. Sounds like the potential starting point of a good STS story, as this point leads us to the heat of financial economics, to CAPM.

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