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Headlines Engle and Granger Win Nobel Prize Tools that help measure risk in stock portfo- lios are among the discoveries that have led to a 2003 Nobel Prize in Economics for two business profes- sors, CliveW.J. Granger and Robert F. Engle. The two were longtime colleagues at the Department of Economics at the University of California in San Diego. Currently, Engle holds the Michael Armellino Professorship in the Management of Financial Services at New York Uni- versity's Stern School of Business. Granger, an emeritus professor of economics at UCSD, was a visiting scholar at Canterbury University in New Zealand last fall. Both still maintain offices at UCSD. While the two men often collabo- risk. If you think in terms of your portfolio, the risk is the possibility that its value might go down, so you'd like to figure out whether or not that's a likely event. When you diversify, for example, you'll find that the risk is less. But also, in the same time period, the risk might be less due to other factors. How are your economic models used in the real world? First, financial institu- tions use these models to forecast risk in many different flavors. They autoregressive conditional het- eroskedasticity (ARCH), revolves around analyzing volatility in the stock market as a way to manage risk. BizEd recently spoke with Engle to discuss his theories. Can you give a layman's definition of the principles behind your research? It's a quantitative approach to measuring 8 BizEd JANUARY/FEBRUARY 2004 rated on projects, they also worked separately on their time-related analy- sis of factors that affect markets. "Economic data has special proper- ties and it requires special tech- niques," says Granger, whose theory of cointegration led to breakthroughs in statistics and macroeconomics forecasting. "I have developed tech- niques that can be used by central banks and federal reserves for fore- casting and policy development. I'm always hoping to make my research practical and useful. It starts out as theory but then one aims to move toward the practical end of things." Engle's key research, known as Granger Engle "I think there ought to be more quantitative tracks in the MBA program. When I consult with investment banks, I find that in a lot of positions where I expect to find MBAs employed, they're not." —Robert Engle are concerned about the risk to their U.S. equity portfolio, their small-cap portfolio, their Tokyo office. An in- vestment bank will typically calculate risks for hundreds or thousands of kinds of exposure every day, and that risk has to be quantified. Second, these models are used to figure what the fair price of an option might be. An option might be some- thing you buy in the market that will pay if the stock goes up but won't pay if the stock goes down. But the question is, how much do you have rent research? I'm actually pushing in two different directions. One is ana- lyzing large collections of assets all at once and whether or not they move together. This makes it a more ap- propriate vehicle for talking about portfolios with collections of assets. The second is measuring these at a higher and higher frequency until there is almost a second-by-second measure of volatilities and correla- tions. Every time there's a new piece of information, like a trade or a quote, you could update your volatil- ity estimates. Do you think business schools could restructure their courses to provide students with better preparation for careers in fi- nance? I think there ought to be more quantitative tracks in the MBA pro- gram. When I consult with invest- ment banks, I find that in a lot of positions where I expect to find MBAs employed, they're not. Banks hire people who have physics degrees but don't know any finance. Schools should be teaching a little more about these statistical models. I think you have to learn those hard skills when you're young. If you pass on this opportunity to learn them, you're just not going to pick them up later in life. How do you expect winning the Nobel Prize to change your life? I'm pretty happy with my life the way it is, so I'm hoping the award won't affect it too much. I do hope it will give recognition to people in this line of research and lead to increased interest in these kinds of research methods. to pay for that? "Put options" will pay off only if a stock goes down, not if it goes up. These are really good ways to protect your portfolio, but the amount they cost is clearly related to how risky they are. What are you looking at with your cur-