The increasing complexity of financial instruments has sent one software developer back to school.
Algorithmics Inc., which makes risk management computer programs used by banks and other financial institutions, has founded a research unit called RiskLab at the University of Toronto. Opened in May, the lab is designed to give academics the tools and resources to study risk management while letting Algorithmics pick researchers' brains.
Algorithmics in encouraging the startup of similar efforts at other universities around the world. The different programs could exchange ideas and information over the Internet, the phone, or through the mail.
"We're trying to create a virtual university for computational finance," Ron S. Dembo, president of the Toronto-based company, said.
Collaborations between the financial services industry and academia are not new, said Deborah Williams, an analyst with the Newton, Mass.-based Tower Group.
However, experts said the virtual university, if it catches on, could hasten advancements in risk management technology.
"The RiskLab network will be the central catalyst to share experiences and results and to encourage international collaboration among universities," said Luis A. Seco, a mathematics professor at the University of Toronto involved in the RiskLab.
A key component in the lab sites is Algorithmics software tools, Mr. Dembo said.
"When I was an academic at Yale and I was teaching classes, we were dying to get hold of software to run proper workshops and to get hands-on training," he said.
Using a set of Algorithmics' programming "objects" - building blocks for software - lab participants search for better ways to perform risk management functions such as value-at-risk calculations and derivatives tracking.
Mr. Dembo said the software tools play an integral role in the research. He said researching risk management without them is like running a chemistry laboratory without test tubes.
Several banks, including Republic New York Corp., are Algorithmics customers. "We're not only going to use them for risk, but our intent is to use them in other areas of the bank as well," said Raymond Tamayo, an executive vice president at the $50 billion-asset bank.
The University of Toronto is the first educational institution using the software, but several others are expected to do so soon, acording to executives at Algorithmics. Cambridge University in England should begin using Algorithmics' software next month.
Though the virtual RiskLab is in its embryonic stage, already it has yielded results, Mr. Dembo said.
Recently he signed two offer letters to former lab members to work on projects that they started at the RiskLab and that now have "taken on a commercial life."
Financial institutions also are getting in on the act. A well-known investment bank in London initiated a research project on a new statistical technique at the RiskLab and now wants to turn the project into a product, Mr. Dembo said.
Risk management software companies commonly look for help in developing new products.
For example, Treasury Services Corp. of Santa Monica, Calif., this year unveiled derivatives risk management software it developed with Kamakura Corp., a Japanese investment banking and risk management firm.
Treasury Services relied upon Kamakura to help find efficient ways to value complex derivatives. The president of the Japanese firm, Donald R. van Deventer, "did a lot of original work to utilize some higher math to generate closed form solutions," said Steve L. Reich, a principal with Treasury Services.
These new solutions could run "much faster" and "deliver more precise valuations" than was previously possible, he added.
Robert Jarrow, a Cornell University professor who is Kamakura's director of research, was also "very active in the development," said Jonathan W. Levin, director of U. S. operations for Kamakura. Mr. Jarrow is "a real pioneer" in financial analytics, he added.
The main benefit of aligning with Kamakura "has really been to our clients," Mr. Reich said, "in that we were able to very rapidly bring them the most advanced techniques available without a major development cycle of our own."
This addition to Treasury Services' offerings reflects a current in the risk management software market.
"There seems to be a trend toward vendors extending their reach in terms of the products they offer," said Scott Stoll, national director of the commercial bank risk management practice of Ernst and Young.
As a software company with few employees in the United States, Kamakura "really needed a distribution channel" for its products, Mr. Levin said. "We were looking a partner in the more traditional asset/liability management area that could utilize our resources and our expertise."
Some banks are beginning to see the fruits of such partnerships.
Toronto-Dominion Bank uses Treasury Services' Treasury Manager software, and its experience led it to test the derivatives package developed with Kamakura.
Although Toronto-Dominion still is using the software on a trial basis, David Tanner, the bank's vice president of asset/liability management, said it "has promise."
"The key hope is that we'll be able to use it to understand the risk inherent in embedded options, such as rate holds and prepayment risk," he said.
The bank also hopes to use the software "to model customer behavior, which in the retail bank is a huge variable - probably the most important variable," Mr. Tanner said.
More alliances between risk management software vendors are inevitable, said John R. Segerstrom, president of ALX Corp., an asset/liability management software firm in Lake Oswego, Ore.
"Ultimately, risk measurement and risk management technology will have to be integrated right into the bank's fundamental operating systems," he said.
"The need to make different software packages work together is going to be critical, but I don't know if that will be achieved necessarily by vendors making formal arrangements themselves," said the Tower Group's Ms. Williams.
One high-profile partnership in risk management involves a bank. J.P. Morgan & Co. is working to improve its risk management technology with the assistance of a data provider. In May, the bank recruited Reuters to help enhance its risk management derivatives and other financial products.
For the past two years, the bank has used a product called Riskmetrics for value-at-risk calculations. Reuters has been brought aboard to help expand the scope of instruments covered by the product.
"Riskmetrics, which was 23 different markets, is now going to be any piece of data in any financial market that Reuters covers," said Ethan Berman, managing director of J.P. Morgan's risk management advisory group.
"We've already extended the data sets to cover more markets," said Martin Spencer, manager of risk data at Reuters.
The next improvement planned is a service that would let users "customize the data set to fit their trading profile," he said. Reuters expects to offer this service in mid-1997, Mr. Spencer said.
The efforts to find partners for managing risk are driven mainly by the regulatory climate which requires banks to value their investments according to the risk the pose, experts said.
Dealing with regulators' new risk-based approach will be "like turning the Titanic on a dime" for some banks, said ALX Corp.'s Mr. Segerstrom.
But through the alliances and research efforts that are generating new software, those banks may get the tools they'll need to deal with the new regulatory environment.
