Managing financial risks from global to local edited by gordon l clark adam d dixon and ashby h b monk

Managing Financial Risks


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Managing Financial Risks:
From Global to Local
Edited by
Gordon L. Clark, Adam D. Dixon, and
Ashby H. B. Monk

1


3

Great Clarendon Street, Oxford ox2 6dp
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For Shirley, Olga, and Courtney

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Contents

Notes on Contributors
Preface
Acknowledgments
List of Figures
List of Tables
Abbreviations

Introduction

ix
xv
xviii
xx
xxi
xxii
1

Gordon L. Clark, Adam D. Dixon, and Ashby H. B. Monk

Part I: Governing Global Financial Risk
1. The Changing Political Geography of Financial Crisis
Management
Louis W. Pauly
2. Financial Governance in the Neo-liberal Era

Gary Dymski
3. Risk Management and Institutional Investors
Gordon L. Clark

27
48
69

Part II: Place, Proximity, and Risk
4. The Practicalities of Being Inaccurate: Steps Toward the Social
Geography of Financial Risk Management
Yuval Millo and Donald MacKenzie
5. Learning to Cope with Uncertainty: On the Spatial
Distributions of Financial Innovation and its Fallout
Ewald Engelen
6. The Role of Proximity in Secondary Equity Markets
Dariusz Wo´jcik

95

120
140

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Contents

Part III: Urban Risk
7. Infrastructure Investment and the Management of Risk

Phillip O’Neill
8. Balancing Risk and Return in Urban Investing
Lisa A. Hagerman and Tessa Hebb
9. Managing Financial Risks in Urban Environments
Samuel Randalls

163
189
209

Part IV: Individuals in a Risk World
10. Managing Financial Risks: The Strange Case of Housing
Susan J. Smith
11. Gender, Risk, and Occupational Pensions
Kendra Strauss
12. Consumer Credit, Self-Discipline, and Risk Management
Paul Langley
Index

viii

233
258
280

301


Notes on Contributors

Gordon L. Clark is the Halford Mackinder Professor of Geography, holds
a Professorial Fellowship at St Peter’s College and is currently a Faculty
Associate in the Smith School of Enterprise and the Environment at Oxford
University. His current research is on pension fund governance focusing
upon the competence and consistency of decision-makers and the design
of rules and regulations to enhance the investment performance of these
crucial institutions (supported by the National Association of Pension
Funds and Watson Wyatt). Related work centers on individual financial
decision-making in defined contribution plans emphasizing the intersection between cognition and context (supported, in part, by the ESRC,
Mercers, and Watson Wyatt). Recent books include The Geography of Finance (OUP, 2007) (with Dariusz Wo´jcik), Pension Fund Capitalism (OUP,
2000), European Pensions and Global Finance (OUP, 2003), and the coedited
Pension Security in the Twenty-First Century (OUP, 2003) and the Oxford
Handbook of Pensions and Retirement Income (OUP, 2006).
Adam D. Dixon is a D.Phil. candidate in economic geography at the
OUCE, University of Oxford. His doctoral research focuses on developing
conceptualizations of European and global financial geography in the
context of globalization and institutional diversity. He holds a graduate
degree from the Institute d’Etudes Politiques de Paris and an undergraduate degree from The George Washington University Elliott School of
International Affairs. He has published in New Political Economy and Soziale
Welt, and has a forthcoming article in the Journal of Economic Geography. He
is also the International Economy Editor for Oxford Analytica.
Gary A. Dymski is founding Director of the University of California
Center, Sacramento (UCCS), and professor of economics at the University
of California, Riverside. He received his B.A. in urban studies from the
University of Pennsylvania in 1975, an MPA from Syracuse University in
1977, and a Ph.D. in economics from the University of Massachusetts,
Amherst in 1987. He was a research fellow in economic studies at the

ix

Notes on Contributors

Brookings Institution in 1985–6. He has taught at the University of Southern California and has been a visiting scholar at Tokyo University, the
Bangladesh Institute for Development Studies, the Federal University of
Rio de Janeiro, and the University of Sa˜o Paulo. Gary’s research spans
economics and geography, focusing on banking, financial instability and
crises, urban development and inequality, and on credit-market discrimination and financial exclusion. Gary’s books include The Bank Merger
Wave (M. E. Sharpe, 1999), and Reimagining Growth: Toward a Renewal of
the Idea of Development, coedited with Silvana DePaula (Zed, 2005).
Ewald Engelen is associate professor at the Amsterdam Metropolitan
institute for Development Studies of the University of Amsterdam. He
was trained as a political philosopher and wrote a Ph.D. thesis about
corporate democracy. After a number of postdoctoral positions, he
moved to the field of economic geography, focusing in particular on the
intricate interactions between welfare state restructuring and financial
markets. After a spell of three years at the Scientific Council for Government Policy, a prestigious public Dutch think-tank, Engelen was awarded a
five-year grant by the Dutch Council for Scientific Research to investigate
the effects of financial internationalization on the historical financial
center of Amsterdam.
Lisa A. Hagerman is the Director of the Mission Investing Campaign
Resource Center at the Boston College Institute for Responsible Investment. She is also affiliated as a Research Associate at the Oxford University
Centre for the Environment, School of Geography, and as a Research
Fellow at the University of North Carolina at Chapel Hill, Center for
Community Capital. In July 2008, she completed her appointment as a
Research Fellow at the Labor & Worklife Program, Harvard Law School
working on the Pension Funds & Urban Revitalization Initiative funded by
the Rockefeller and Ford Foundations. Lisa Hagerman was previously a
Vice President of Economic Innovation International, a Boston consulting
firm that builds privately capitalized community equity funds. Prior to her

consulting work Ms. Hagerman was with Wells Fargo Bank, San Francisco,
as Assistant Vice President in the Government Relations group and also
worked for Citibank, New York, for seven years in the Latin American
Marketing Division. She completed her doctorate in economic geography
at the University of Oxford on Public Pension Fund Investment in Urban
Revitalization. Ms. Hagerman received her B.A. from Bucknell University
and her M.A. in political science from the University of North Carolina at
Chapel Hill.

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Notes on Contributors

Tessa Hebb is the Director of the Carleton Centre for Community Innovation, Carleton University, Canada. Her research focuses on the financial
and extra-financial impact of pension fund investment in Canada and
internationally with particular emphasis on Responsible Investment and
Corporate Engagement and is funded by the Social Sciences and Humanities Research Council, Government of Canada. The Carleton Centre for
Community Innovation is a leading knowledge producer on social finance
tools and instruments. Dr Hebb is also a senior research associate with
the Oxford University Centre for the Environment and the Initiative for a
Competitive Inner City. In 2008, she completed a multi-year research
project funded by Rockefeller and Ford Foundations on the role of US
public sector pension funds and urban revitalization, based at the Labor
and Worklife Program, Harvard Law School. Dr Hebb has published many
articles on pension fund investing policies and is the coeditor of the
volume Working Capital: The Power of Labor’s Pensions. Her new book No
Small Change: Pension Fund Corporate Engagement was published in September 2008 by Cornell University Press.
Paul Langley studied politics, history, and international political economy at the University of Newcastle-upon-Tyne. He is currently Senior
Lecturer in Politics at Northumbria University. Paul recently completed a

three-year term as Convenor of the International Political Economy
Group (IPEG) of the British International Studies Association (BISA), and
is presently an editor of the Review of International Political Economy Series
(Routledge). He is the author of The Everyday Life of Global Finance: Saving
and Borrowing in Anglo-America (OUP, 2008), and World Financial Orders
(Routledge, 2002). His most recent research has focused on the intersections between housing, financial, and mortgage markets in the context of
the sub-prime crisis, and has been published in Economy and Society. During 2009–10, Paul will hold a Fellowship at the Institute of Advanced
Studies (IAS), Durham University, and will be exploring ‘‘The Performance
of Liquidity.’’
Donald MacKenzie works in the sociology of science and technology and
in the sociology of markets, especially of financial and carbon markets. He
holds a personal chair in sociology at the University of Edinburgh, where he
has taught since 1975. His first book was Statistics in Britain, 1865–1930: The
Social Construction of Scientific Knowledge (Edinburgh University Press, 1981).
His most recent are An Engine, not a Camera: How Financial Models
shape Markets (MIT Press, 2006) and Do Economists Make Markets? On the

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Notes on Contributors

Performativity of Economics (Princeton University Press, 2007), co-edited with
Fabian Muniesa and Lucia Siu.
Yuval Millo is a lecturer in the Department of Accounting at the London
School of Economics. He applies theoretical approaches from sociology of
science and economic sociology along with a combination of qualitative
and quantitative methods to the study of financial risk management and
corporate governance. He is one of the leading contributors to the evolving field of the social studies of finance. His latest publication is Market
Devices (Blackwell, 2007, with Michel Callon and Fabian Muniesa).

Ashby H. B. Monk is a Research Fellow at the University of Oxford and
a Research Fellow at Boston College’s Center for Retirement Research. He
received his D.Phil. in Economic Geography at Oxford and holds an M.A.
in International Economics from the Universite´ de Paris I–Panthe´on Sorbonne and a B.A. in Economics from Princeton University. His current
research is on the design and governance of financial institutions, with
particular focus on pensions and sovereign wealth funds (supported by the
Center for Retirement Research at Boston College, the Leverhulme Trust,
and the Lupina Foundation). He has published numerous academic papers
related to the above, and is the co-author of a forthcoming book entitled
Sovereign Wealth Funds: Power, Governance, and Legitimacy (Princeton University Press).
Phillip O’Neill is Professor and Foundation Director of the Urban Research Centre at the University of Western Sydney. His research interests
are in the broad field of economic geography. Phillip has made distinguished contributions to the study of the investment and employment
practices of major international corporations, the conduct of government
institutions, the contemporary reformation of major cities, and the application of quantitative methods and geographic information systems (GIS)
technologies to analysis of the performance of cities and regions under
economic and demographic stress. His current research interests focus on
the role of corporate power in the contemporary city, with an emphasis on
infrastructure and infrastructure financing. Phillip is also a prominent
public commentator on economic and social change in cities and regions.
He is a regular op-ed columnist and commentator in the Australian national media.
Louis W. Pauly holds the Canada Research Chair in Globalization and
Governance and directs the Centre for International Studies at the
University of Toronto. A graduate of Cornell University, the London

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Notes on Contributors

School of Economics, New York University, and Fordham University, he

has been a visiting professor at Oxford University, Northwestern University, and Osaka City University, held management positions in the Royal
Bank of Canada, and served on the staff of the International Monetary
Fund. His publications include Global Ordering: Institutions and Autonomy
in a Changing World (UBC Press, 2008), Complex Sovereignty: Reconstituting
Political Authority in the Twenty-First Century (University of Toronto Press,
2007), and The Myth of the Global Corporation (Princeton University Press,
1998). With Emanuel Adler, he edits the journal International Organization.
His current research focuses on the politics of technological innovation in
East Asia and on crisis management in integrating financial markets.
Samuel Randalls is a lecturer in geography at University College London.
Prior to that he held a James Martin Fellowship in the Environmental
Change Institute at the University of Oxford and completed his Ph.D.
at the University of Birmingham. His research interests and publications
encompass areas of environmental finance, particularly weather derivatives and carbon markets. He is currently exploring cultural and historical
aspects of climate change, the relations between businesses, meteorology
and the weather, and other new corporate ventures in environmental
sustainability.
Susan J. Smith is a Director of the Institute of Advanced Study, and
Professor of Geography, at Durham University. She has recently completed
a program of work, funded by the UK’s Economic and Social Research
Council, on the close encounter between housing, mortgage, and financial markets. Using qualitative methods alongside more conventional
quantitative tools, this work has contributed to a growing literature on
housing investment, mortgage equity withdrawal, and housing market
risk. Among more than 100 scholarly works accounting for the economic
and social geography of inequalities of all kinds, Susan has recently coedited a theme issue on the microstructures of housing markets (Housing
Studies, 2008) and the rematerialization of home (2008), as well as a
Blackwell companion to the economics of housing (2009). She is currently
Editor in Chief of the International Encyclopedia of Housing and Home
(Elsevier, 2011).
Kendra Strauss is a Research Associate in the School of Geography, Oxford

University Centre for the Environment. She holds a B.A. (Hons) in Cultural
Studies from McGill University and an M.Sc. (Distinction) and D.Phil. from
Oxford University. She is broadly interested in issues to do with gendered

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Notes on Contributors

inequality, the social and cultural embeddedness of economic practices,
and the future of the welfare state. Her doctoral research, which was
supported by the UK Economic and Social Research Council, the Canadian
Social Sciences and Humanities Research Council, and Mercer Human
Resources Consulting, focused on choice, risk, and responsibility in defined contribution occupational pensions in the UK.
Dariusz Wo´jcik is a Lecturer at the Oxford University Centre for the
Environment and a Fellow of St Peter’s College Oxford. Prior to his current
appointment he was a consultant for KPMG Poland (1996–8), a scholar of
the Open Society Institute and the Foreign & Commonwealth Office and a
D.Phil. student at Oxford (1998–2002), a Junior Research Fellow at Jesus
College Oxford (2003–5), and a Lecturer at University College London
(2006–7). He held visiting teaching positions at the London School of
Economics and Political Science, and the Graduate Business School
of the Hong Kong Polytechnic University, and gave invited lectures at
the Annual Dublin Finance Conference and to the Polish Securities and
Exchange Commission. His research is concerned with the intersection of
geography and finance, with emphasis on the geography of financial
services and centres, capital markets, and corporate governance. He is
the guest editor of the special issue of Growth and Change on European
Financial Geographies (2007), and a co-author of The Geography of Finance:
Corporate Governance in the Global Marketplace (OUP, 2007). His research

has been reported in the Financial Times, the Financial News, and by
Bloomberg.

xiv


Preface

This book is about the management of financial risk, drawing inspiration
from a new generation of scholars working at the interface between financial markets and the academic fields or disciplines of economic geography,
economics, sociology, and political science. The book is designed to showcase their research and, most importantly, articulate the links between
financial processes operating at a variety of geographical scales – hence
the subtitle ‘‘From Global to Local.’’ Equally, the subtitle could be ‘‘From
the Local to the Global.’’ We leave it to our contributors to articulate the
local–global–local connection in ways that help us understand what is in
play in global markets, national institutions, and local communities.
The book was conceived in early 2007, before the tremors in global
financial markets became a sub-prime crisis and then a global financial
and economic crisis. At the time, we were conscious of an apparent yawning gap in the academic literature: for all the sophistication of mathematical financial models, we could see that asymmetries of information
between market participants located in various jurisdictions and located
at different levels in the spatial hierarchy of financial centers threatened
the integrity of the whole. Our intuition was that the value of information
for embedded market participants was being discounted by both the flow
of transactions from the local to the global and by the perfection of
mathematical models that deliberately eschewed local knowledge in
favor of formula-based risk-management on a global scale.
Our insight in this matter was not entirely new; financial economics has
always been interested in the nature and flow of information in markets –
there is, after all, a premium on information that is not widely available,
held by interested parties, and sold to the highest bidder. This is expressed

in many different ways, including the relative sophistication of market
players such as institutional investors located close to trading centers and
day-traders remotely located (in time and space). Just as importantly, the
flows and channels of market information have been heavily influenced
by national traditions. We have worked here and elsewhere to articulate

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Preface

the logic whereby information asymmetries are not just a product of
happenstance, always driven out of the market by virtue of efficient market pricing, but are systematically embedded in that which is inherited
and that which is a product of the restless risk-seeking behavior of financial agents.
At another level, the tension between the local and the global has been
one of those issues that has attracted close scrutiny over the past decade or
so by those academics and market agents interested in conceptualizing
market structure and performance. We refer here, of course, to the work of
Clark and O’Connor on the consequences of systematic informational
asymmetries for the form and functions of financial centers, the work
of Moskowitz and colleagues on the market for information, and the
work of Shiller on the incompleteness of macro-markets and the consequent behavioral patterns including herd behavior and ‘‘irrational
exuberance.’’ Similarly, sociologists like MacKenzie have sought to better
understand how the adoption of certain analytical frameworks has
effectively driven out of the market information that ought to have a
price but which has been discarded because of its lack of ‘‘relevance.’’
Notwithstanding our analytical intuition, we were unprepared for the
rapid transformation of the sub-prime crisis into a global financial and
economic crisis. Whereas our approach to financial risk management is
consistent with the production, spread, and depth of the sub-prime crisis,

our contributors prompted us to make the widest possible links to global
financial governance. Here, then, is one of the strengths of the book: we
begin with this most contentious of issues and take the reader down
through the spatial scale to the individual financial ‘‘actor.’’ Along the
way, our contributors reach out – upwards and downwards – showing how
risk-management at one level is connected with related factors operating
at a variety of scales. This, we believe, has been one of the lessons of the
global financial crisis; it seems that no corner of the global financial
system has been left unscathed although at its heart the costs of failure
in financial governance have been heavily concentrated – just ask residents of North East England and Charlotte, North Carolina (and more
besides) who have borne significant costs from the failure of regionally
dominated financial institutions.
A central theme of the book is the significance of the global and local
financial sector. This is shown for a variety of sectors and industries – from
market structure to market performance, from models of management to
individual decision-making, from housing to pensions, from urban infrastructure to development and so on. Whether it survives as such in the

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Preface

aftermath of the global financial crisis is difficult to know. Clearly, there
will be concerted attempts to exact compensation and revenge for misdeeds and malfeasance through state regulation. But it seems to us that
finance will remain important for nations and communities; indeed, it
will remain one of the cornerstones of globalization. What shape it will
take, how the importance we attribute to risk management will be integrated into financial decision-making, and how innovation will be managed such that the costs of failure remain located with those that promote
new kinds of financial products spread around the globe are profound
questions that may take another ten years to resolve.
Most importantly, our book is not so much about the sub-prime crisis

and the global financial crisis as it is a report from the frontiers of academic
research on topics we believe will be with us far into the future. Whatever
happens to the form and structure of financial institutions, the nature and
scope of regulation, and the degree to which financial institutions blur the
boundaries between ‘‘public’’ and ‘‘private’’, we believe the functions of
risk-management relevant to the issues raised in this book will be very
important over the coming decades. Take just three examples. Given the
entwining of national pension policy and financial markets in many
countries over the past fifty years, without nationalization of private
pensions how will pension institutions deal with risk management? Likewise, how are the risks associated with housing markets and mortgages to
be managed without simply making housing a luxury good? And what
about the design of carbon markets? Current models match and mimic the
risk-management techniques of financial markets. Given the significance
of this issue for global well-being, will government regulation be an adequate mechanism to realize the changes that must take place over the
next twenty-five years?
We do not pretend to have a recipe for the future of each and every sector
studied in the book. But we do think that each chapter provides a way of
thinking about risk-management that steps outside of simple models to
give the heterogeneity of information and behavior its due. We hope this
book will promote a closer analysis of how the local became global and vice
versa in twentieth-century financial markets. We also hope that articulating these linkages will encourage a view of finance that is cognizant of its
practice.
Gordon L. Clark, Adam D. Dixon, and Ashby H. B. Monk
Oxford, October 2008

xvii


Acknowledgments

The impetus for the book goes back to a train ride from Lancaster to
Oxford in January of 2007. Having just participated in a two-day workshop
on financial geographies hosted by James Faulconbridge and Ewald
Engelen, we agreed with Louis Pauly that we should keep the discussion
going. To that end we organized a series of invited seminars for the spring
of 2007. Eight seminars took place in Oxford on the subject of financial
risk management and the geography of finance from April through to June
of 2008. The reception of this seminar series was extremely positive, so
much so that we felt there was scope to further expand the project.
With Oxford University Press formally interested in publishing the
book, we commissioned papers from our seminar participants and those
we thought could take us into other important areas relevant to the local–
global connection. As an interim point, we then sponsored a series of
sessions on the drafts of papers at a major international conference in
the spring of 2008, giving the authors an opportunity to see each others’
work and write their own chapters with others’ work in mind. Finally, after
receiving completed rough drafts in the summer of 2008, the editors
critiqued, commented and redistributed the drafts of chapters for revision
and cross-referencing. Final chapters were submitted in the fall of 2008.
The process in its entirety has taken nearly two years.
As the above suggests, an edited volume requires the input and hard
work of many people. As such, we would like to acknowledge specific
contributions of certain people and institutions. First, we would like to
thank the contributors. Without their flexibility and hard work, this book
would not have been possible. In addition, the project has been supported
by the Oxford University Centre for the Environment and Oxford University Press. Indeed, David Musson of OUP has been instrumental in this
book’s success. The authors would especially like to thank Jan Burke for
logistical support.

xviii

Acknowledgments

Gordon L. Clark would like to thank Shirley for her steadfast support
over the past seven years. Ashby H. B. Monk would like to thank Courtney
for continuing enthusiasm and interest. Adam D. Dixon would like to
thank Olga for her patience and support, as well as his parents for their
permanent enthusiasm.

xix


List of Figures

3.1. A resource-based typology of pension fund decision-making

77

3.2. Self-assessed preferred mode of action and planning in
decision-making

81

3.3. Self-assessed confidence in personal and collective decision-making

82

4.1. Number of options contracts traded in all options exchanges
and average number of contracts per transaction in CBOE, 1973–90

98

5.1. Trends in securitization issuance

125

7.1. The life cycle of infrastructure as a financial product

173

7.2. The corporate structure of Macquarie Group Ltd

175

7.3. How Macquarie Group does business

178

7.4. The Macquarie Group business model

178

xx


List of Tables

5.1. Securitization issuance by country of collateral

126

7.1. Macquarie Bank’s operating income, 2007–8 fiscal year (ending March)

176

7.2. Adjacency at work in China

180

8.1. MassPRIM asset allocation as of June 30, 2007

195

8.2. Opportunity fund risks and risk mitigation

198

xxi


Abbreviations

ABS

Asset Backed Securities

AIM

Alternative Investment Management Program

AMEX

American Stock Exchange

BIS

Bank for International Settlements

CBOE

Chicago Board Options Exchange

CDDs

Cooling Degree-Days

CDO

Collateralized-Debt Obligation

CDVCA

Community Development Venture Capital Alliance

CIC

China Investment Corporation

CME

Chicago Mercantile Exchange

CRT

Chicago Research and Trading

DC

Defined Contribution

ECB

European Central Bank

ECOFIN

Economic and Financial Affairs Council of the European Union

EDM

Emerging Domestic Market

ESCB

European System of Central Banks

ESG

Environmental, Social, and Governance

ETI

Economically Targeted Investing

FACT Act

Fair and Accurate Transactions Act

FOX

London Futures and Options Exchange

FSA

Financial Services Authority

FSAP

Financial Services Action Plan

GARP

Global Association of Risk Professionals

HDDs

Heating Degree-Days

IMF

International Monetary Fund

IRR

Internal Rates of Return

LCFI

Large Complex Financial Institution

xxii


Abbreviations
LCTM

Long-Term Capital Management

MassPRIM

Massachusetts Pension Reserves Investment Management Board

MBSs

Mortgage-Backed Securities

MEL

Macro-Economic Linkages

MPT

Modern Portfolio Theory

NCREIF

National Council of Real Estate Investment Fiduciaries

NPSS

National Pension Savings Scheme

OCC

Options Clearing Corporation

ONS

Office of National Statistics

OTC

Over-The-Counter

P/E

Market Price To Earnings

PBW

Philadelphia-Baltimore-Washington Stock Exchange

PHLX

Philadelphia Stock Exchange

PSE

Pacific Stock Exchange

SEC

Securities and Exchange Commission

SIVs

Structured Investment Vehicles

SSF

Social Studies of Finance

TMT

Technology, Media, and Telecom

VA

Value-Added

VaR

Value At Risk

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