F741: Intro to Fintech

Professor Malinova

What is FinTech?

Why now?

Lecture 1:

Technological Innovation has always affected trading ....

Old days of trading: highly specialized humans

Modern Day Trading

Autonomous Algorithms run the show

Modern Day Trading

Trading floors are more suited for parties and journalists

Modern Day Trading

And the former heart of Wall Street is now in a faceless & glamourless suburb of Mawah, NJ

What drove this change of Wall Street (and the demise of the NYSE as we knew it)?

Why? The machines ...

Many trading strategies are more-or-less mechanical/probabilistic
computers are
- faster,
- cheaper, and
- more reliable
Computer algos allow much wider scope

Source: Bloomberg News, Feb 20, 2015

Note: The biggest disruptors (the HFTs) came from the outside of the traditional system (kinda).

Why? The HR ...

Old skill-set of an equity trader
- good and fast with numbers
- brash
- strong vocab in profanities
- whatever this koala has...
New skill set
- programming
- stats/data
- econometrics
- ....

The result?

entire career streams disappear

MIT Technology Review, Feb 07, 2017

Markets get better: the post earnings announcement drift had been a long-standing puzzle in finance. ... It's gone.

What's the impact?

Source: Martineau (UofT) (WP2017)

The world of Finance as we know it is over

TFSA study on the Future of the Financial Industry

GTA: 800,000 jobs in FI

50% of executives believe that 40% or more of these jobs will change fundamentally over the next 3-5 years

Source: "Unlocking the human opportunity: Future-proof skills to move financial services forward"; PwC report for the Toronto Financial Services Alliance, April 2018

TFSA study on the Future of the Financial Industry

What is FinTech?

Finance

Technology

usually post 2008

outside of traditional financial institutions

goal: disrupt existing FIs

this is really squishy ...

(Or is it?)

Why was/is it inevitable that finance would get disrupted?

in a nutshell: why people choose to work in finance

relative wage=avg wage in finance/avg rest of economy

Source: Philippon (AER 2015) "Has the U.S. Finance Industry Become Less Efficient?"

The Growth of Finance as % of GDP

Source: Philippon (AER 2015) "Has the U.S. Finance Industry Become Less Efficient?"

... and unit costs are flat!

Source: Philippon (AER 2015) "Has the U.S. Finance Industry Become Less Efficient?"

Ratio of the income of financial intermediaries to the quantity of intermediated assets

Workers in the Finance Industry benefit greatly from growth of finance

Philippon and Reshef (QJE 2012):
- 1980: wage financial services=wage other industries
- 2006: financial services=170% x other
Goldin & Katz (AER 2008)
- 1969-74: 6% of Harvard grads went to Fin Industry
- 2006: 28%
Oyer (JF 2008):
- wages Stanford GSB grads in finance industry
  - 300% of wages in non-finance

What explains high wages?

High quality?
- Bai, Philippon, Savov (JFE 2013): No, markets haven't become any better/more informative.
Better allocative efficiency?
- Aguiar and Bils (AER 2015): no improvement in risk sharing.
- No evidence that allocative efficiency has improved (typically measured by "total factor productivity" (TFP)).
There is a dispute whether growth in finance has actually brought benefit to society ...

And then there's this:

which led to ...

High cost industries with high rents?

\(\Rightarrow\) Disruptive entry is bound to take place!

Key drivers?

But why "now" (after 2008)?

Main structural changes?

Main Structural Change

Fastest Computer in 1985!

Main Structural Change

Moore's Law

"the number of transistors per square inch on integrated circuits had doubled every year since their invention."

(& the cost halved)

Moore's Law: the future

A Tale of Railroads

US Standard railroad gauge (distance between the rails) is 4 feet, 8 1/2 inches

Because that's the way they built them in England

that's the gauge used for pre-railroad tramways

the same jigs and tools that they used for building wagons, which used that wheel spacing

other wheels would break on old roads. Because that's the spacing of the old wheel ruts

The first long distance roads in Europe were built by Imperial Rome

Economic Insights for Regulation?

New risks

Functions and entities that create market failures change or disappear:
- fewer intermediaries \(\to\) fewer agency conflicts
  - but: new entities hold deposits
- smart contracts \(\to\)real-time view of transactions
  - but: only as "smart" as their source code (code audit?)