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Revolutionary Finance From Russia

By Nina Mehta

Grand unifying theories are hard to come by and difficult to understand. There’s quantum theory, the theory of relativity and string theory, just to name a few. Those, however, are in physics.

Now the field of finance has one of its own. It’s called “Beliefs-Preferences Gauge Symmetry Group and Replication of Contingent Claims in a General Market Environment”—or P28 for short.

The man behind the theory is Valery Kholodnyi, a Moscow-educated applied mathematician who works at the Institute for Financial Technology, a research subsidiary of Integrated Energy Services, an energy consulting and trading company based in Research Triangle Park, N.C.

Unfortunately, Kholodnyi’s theory isn’t likely to be proven anytime soon. The IFT, which is looking for development funds, predicts that it will cost approximately $10 million and take two to three years to develop the science properly. Right now, there is no model, no formula or set of algorithms, and no software to test the validity of Kholodnyi’s science.

The Russian mathematician is also a bit off the conventional academic research path. Although 2,000 copies of the 460-page book explaining his theory were published privately by the institute last year, no parts have appeared in a peer-reviewed journal. (P-28, incidentally, got it’s name because Kholodnyi’s institute has 34 intellectual properties and this is No. 28.)

Those around Kholodnyi concede that P-28 is dense and difficult to get across, but Steve Rideout, the institute’s managing director, tries: It is a science, he says, that “allows one to generate the price of an option without any volatility or probability distribution. And it does this in a completely new manner—by identifying the underlying gauge symmetry group [a concept from physics] that all financial transactions are attached to. So when something is traded, we can generate from the price of the underlying security the price of all the options around that security. That’s a revolutionary capability.”

“With P-28,” adds Kholodnyi in a heavy accent, “it is possible to describe, at any given point in time, the set of all market participants, with all their diversified features, in terms of their beliefs and preferences, based on the beliefs-preferences gauge symmetry group. This is one miracle, and it is beautiful from an aesthetic point of view.”

In addition, he says, “since we can describe the beliefs and preferences of all market participants that populate the marketplace, we can construct prices of derivative contracts that are independent of their beliefs and preferences. That is the second miracle. Prices will be fair and objective.” (For more information, see www.ieslc.com.)

Kholodnyi believes that once P-28 allows for the objective pricing of derivative contracts, portfolios can be truly risk-neutral. “This tool will provide people with the ability to evaluate contingent claims in a way that doesn’t depend on the beliefs and preferences of market participants,” he says. “I hope that markets will become a place of prudence and integrity, and that in the future less advantage will be taken of people. It is also my sincere hope that markets will become more fair and efficient.”

Whatever economists may think of P-28, they can probably agree with that.


Go To Jail—For 33 Months!

On december 7, 1998, Thomas Edmund Kelly and Andrew David Rhee were each sentenced to 33 months in prison for their roles in a scheme to front-run futures trades at John Henry & Co.

According to court documents, Kelly, a commodity trading specialist at the firm, appropriated confidential proprietary program-trading information about his company’s future trades. He then passed the information along to Rhee, a commodity trading adviser, who used the information to earn more than $4.7 million trading in commodities futures. Their story was featured in a Derivatives Strategy comic (“Front-running in the Futures Market,” May 1998).

The sentences are unusually lengthy for a financial case, but Justice Department officials believe they will serve as a deterrent to future crimes. Under federal sentencing guidelines, sentences can be lengthened upward for cases involving “abuse of a position of trust” or “use of a special skill.”

Because federal inmates generally serve 85 percent of their sentences, Kelly and Rhee are likely to spend at least two years in a federal correctional facility. Although the nature of their crimes would likely permit them to serve their sentences at a prison with the lowest-security level, a Bureau of Prisons spokesperson stressed that these facilities are far from country clubs. “These camps have an intense focus on work,” he explained. Kelly and Rhee will spend eight hours a day performing sanitation, grounds-keeping or laundry duty, and living in bunks in four-to-eight-person dormitory units. He added that inmates at low-security prisons may also find themselves called to work at medium-security prison facilities or at military institutions.


James Lam’s Ideal Job

Last year, James Lam, the chief risk officer at Fidelity Investments, went to Oliver Wyman & Co. with a business plan that laid out a strategy for developing an enterprise-wide consulting, brokerage and technological company. “It was my way of asking,” he explains, “What is the ideal job for James Lam?”

The dreaming paid off. A few months later, Lam accepted a job at the firm as partner and global head of Enterprise Risk Solutions, a new business division that will provide enterprise risk management consulting and transaction advisory services to financial institutions and corporations.

Lam believes that more companies are now realizing that managing market, credit and operational risk in separate silos doesn’t work. He thinks he can help firms integrate things on an enterprise-wide basis.

That, however, is only half the task. Although more companies understand the need to integrate their risk analysis, their hedging strategies remain disaggregated. “Firms buy insurance products for property and casualty exposures; they buy errors-and-omissions policies; they buy directors’ liability insurance; they buy financial hedges such as foreign exchange contracts and credit derivatives,” says Lam. “But the results are less than optimal.” He thinks it’s time for new, hybrid financial and insurance products that can tackle firm-wide exposures, and is currently in talks with a few insurance companies to develop what he describes as “multi-risk, multiyear products that will help companies optimize their risk profiles.” Bundling these hedging policies, he adds, will achieve efficiencies that should help reduce costs significantly.


Briefly
  • Richard Dunn has been promoted to senior vice president and head of global risk and credit management at Merrill Lynch & Co. He had been cohead of global equity markets.
  • Laz Gonzalez has been named vice president of sales and marketing at CastleNet. He was previously director of web sales at Baan Co.
  • The Deutsche Borse has announced a number of appointments. Michael Kuhn and Christoph Lammersdorf have been named to the executive board, and Reto Francioni has been appointed deputy chairman. Kuhn will be the chief IT officer, Lammersdorf will be in charge of the information products division, and Francioni will be responsible for the cash market and the Xetra division.
  • The International Swaps and Derivatives Association has selected Nick Collier to be deputy director of its European office in London. Collier had been first secretary for financial services, direct tax and statistics at the U.K. permanent representation to the European Union.
  • Sandy Batten has been named senior research analyst at CDC Investment Management Corp. He had been a senior economist at Citibank.
  • The Philadelphia Stock Exchange has announced five appointments. Edith Hallahan was named first vice president and deputy general counsel; Joseph Jennings was named first vice president and acting chief financial officer; William Terrell has been named first vice president of trading floor operations; James Farmer has been named vice president of marketing; and Thomas Kelly was named vice president and controller.
  • Mark Craig has been named vice president of operations at Advanced Financial Solutions. He had been a consultant and past president at SIA Technologies.
  • The National Association of Securities Dealers has appointed John Tognino executive vice president of global sales and member affairs for the Nasdaq-Amex Market Group. Tognino was previously president and CEO of the Security Traders Association and the STA Foundation.
  • Jim Whitesides has been promoted to vice president of energy trading at AmerenEnergy. He had been director of power trading.
  • The Chicago Mercantile Exchange has made a number of appointments. Timothy Keefauver has been named vice president of technical services; John Goode has been named vice president of electronic trading systems; James Moran has been named vice president of market regulation; Jamie Parisi has been named vice president of planning and finance; and Jeffrey Wagner has been named vice president of clearing and regulatory systems.
  • John Cusack has joined Innovest Strategic Value Advisors as CEO. He was previously the founder and president of Gifford Park Associates.
  • C-ATS Software has named Steven Rogers a principal in C-ATS Consulting for Europe. He had been responsible for a senior IT consultancy practice at Logica GmbH in Germany.
  • Bruce Bennett has been named partner at Howard, Smith & Levin. He had been associate general counsel at General Electric Capital Corp.
  • Algorithmics has appointed Anita Dreichler vice president and general manager of North American operations. She had been president of BT Financial Services Information Management Systems at Bankers Trust.

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