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Financial markets are complex structures, even after attempts to rationalize them - and an MIT Sloan professor offers an insight into how its quirks and behaviors work.

Haoxiang Zhu, a Gordon Y. Billard Professor of Management and Finance at the Massachusetts Institute of Technology's Sloan School of Management, has focused efforts over the last decade to conduct theoretical and empirical studies to shed light on how markets are designed. 

"When we need to reform markets, what should we do?" inquires Zhu in an article from MIT. He inquires on market structures having imperfections and how can these be "refined," explaining that these are the questions he aims to answer with his work.

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Zhu's Examinations on Market Behaviors

Recently, Zhu published a paper inquiring whether bank regulations harm market liquidity. It examines the Dodd-Frank banking legislation of 2010 - the federal law that overhauled US regulations in an attempt to prevent another recession from happening.

As the law changed trading, especially for credit default swapping, through centralized mechanisms that bring together prospective investors and dealers, instead of previous one-on-one connections in the market. The research team including Zhu commends the positive impacts brought about by the legislation, suggesting a few points for improving its provisions.

In 2017, Zhu was the co-author of a study that shows how transparent and reliable benchmark pricing for over-the-counter markets, demonstrating its benefits by increasing beneficial trade. Additionally, this practice supposedly helps investors better understand acceptable costs and dealers in the market.

As a case in point, the researchers behind the study used the London Interbank Offered Rate, or LIBOR. In 2012, LIBOR was the benchmark for interest rates used in derivatives equivalent to hundreds of trillions of dollars. Researchers showed that the price manipulation scandals for both LIBOR and EURIBOR - Euro Interbank Offered Rate - has adversely affected investor confidence in these financial benchmarks. In EURIBOR, out of its 44 participating banks, 18 have already dropped out of its participating panel following the scandals.

The paper, which emphasizes the need for robust benchmarks instead of scrapping them, was awarded the Amundi Smith Breeden Prize in 2017.

 

Continuous Work with Policy Experts and Students

Haoxiang Zhu maintains a dialogue with both policy experts, aside from his time as a professor at MIT. In a 2017 study, Zhu and his colleagues analyzed the optimate stocks trading frequency. Their team observed that in terms of setting prices, companies with smaller caps benefit from trading their stocks less frequency compared to the larger businesses. The MIT article notes that such findings drive Zhu to find ways to structure stock markets, with the professor maintaining dialogues with experts.

"I think this sort of analysis does inform policymaking," Zhu explains. He adds that creating informed rules is not easy, requiring time and resources to discover evidence.

In terms of being a professor, he recognizes the challenge of moving from being a good student to creating good research. He likens research to starting up a company. "It's not easy. We do our best to help them, and I enjoy interacting with them," the MIT Sloan professor added.

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