Yuval Millo

Constructing a Market, Performing Theory: The Historical Sociology of a Financial Derivatives Exchange 1

This analysis of the history of the Chicago Board Options Exchange explores the performativity of economics, a theme in economic sociology recently developed by Callon. Economics was crucial to the creation of financial derivatives exchanges: it helped remedy the drastic loss of legitimacy suffered by derivatives in the first half of the 20th century. Option pricing theory—a “crown jewel” of neoclassical economics—succeeded empirically not because it discovered preexisting price patterns but because markets changed in ways that made its assumptions more accurate and because the theory was used in arbitrage. The performativity of economics, however, has limits, and an emphasis on it needs to be combined with classic themes in economic sociology, such as Granovetterian embedding and the way in which exchanges can be cultures and moral communities in which collective action problems can be solved.

Resources or Power? Implications of Social Networks on Compensation and Firm Performance

Using a sample of 4,278 listed UK firms, we construct a social network of directorship-interlocks that comprises 31,495 directors. We use social capital theory and techniques developed in social network analysis to measure a directors connectedness and investigate whether this connectedness is associated with their compensation level and their firms overall performance. We find connectedness is positively associated with compensation and with the firms future performance. The results do not support the view that executive and outside directors use their connections to extract economic rents. Rather the company compensates these individuals for the resources these better connections provide to the firm.

Drilling through the Allegheny mountains: liquidity, materiality and high-frequency trading

In 1999, Carruthers and Stinchcombe provided the classic discussion of ‘the social structure of liquidity’: the institutional arrangements that support markets in which ‘exchange occurs easily and frequently’. Our argument in this paper is that the material aspects of these arrangements – and particularly the materiality of prices – need far closer attention than they normally receive. We develop this argument by highlighting two features of new assemblages that have been created in financial markets since 1999. First, these assemblages give sharp economic significance to spatial location and to physical phenomena such as the speed of light (the physics of these assemblages is Einsteinian, not Newtonian, so to speak). Second, they have provoked fierce controversy focusing on ultra-fast ‘high-frequency trading’, controversy in which issues of materiality are interwoven intimately with questions of legitimacy, particularly of fairness.

The Usefulness of Inaccurate Models: The Emergence of Financial Risk Management

Is the growth of modern financial risk management a result of the accuracy and reliability of risk models? This paper argues that the remarkable success of todays financial risk management methods should be attributed primarily to their communicative and organizational usefulness and less to the accuracy of the results they produced. This paper traces the intertwined historical paths of financial risk management and financial derivatives markets. Spanning from the late 1960s to the early 1990s, the paper analyses the social, political and organizational factors that underpinned the exponential success of one of todays leading risk management methodologies, the applications based on the Black-Scholes-Merton options pricing model. Using primary documents and interviews, the paper shows how financial risk management became part of central market practices and gained reputation among the different organisational market participants (trading firms, the options clearinghouse and the securities regulator). Ultimately, the events in the aftermath of the market crash of October 1987 showed that the practical usefulness of financial risk management methods overshadowed the fact that when financial risk management was critically needed the risk model was inaccurate.

Making things deliverable: the origins of index‐based derivatives

Index-based derivatives: financial contracts that use financial market indices as their underlying ‘assets’ are currently amongst the most commonly traded financial contracts (BIS, 2006). Furthermore, the introduction of index-based derivatives is considered by many as the single most significant development in contemporary financial markets (Chance, 1995; Arditti, 1996; Kolb, 1997a, 1997b). The use of index-based futures has become a standard practice in the financial world and today banks, pension funds, insurance companies and governments hold portfolios that include index-based derivatives. In fact, indexbased contracts have become such an indispensable feature of the global financial system that it would be safe to say that there are many millions in the West who own, either directly or indirectly (even unknowingly), index-based derivatives. In spite of their ubiquity in the financial world, index-based derivatives represent a fundamental ambiguity. Derivative contracts, as their name implies, derive their prices from the prices of a variety of assets, such as agricultural commodities, precious metals, currencies and many others. The contract themselves, (eg, futures contracts), state the terms of future transaction: price to be paid and time for the delivery of assets. In contrast with physical and deliverable assets, market indices are the products of mathematical procedures applied to market data. Hence, index-based derivatives are contracts written for ‘strange assets’, assets that do not have straightforward physical characteristics, and therefore cannot be delivered, upon buying and selling, in a similar manner to physical assets. This fact raises an interesting historical and sociological question: how did it happen that these abstract mathematical entities became the basis for the most popular financial contract of our time? More specifically, how did the non-physical and non-deliverable nature of market indices change in such a way that allowed indices to serve as a basis for the popular derivative contract we know today? This is the question that this chapter discusses. Economic sociology has paid little attention so far to the evolution of indexbased contracts. Several sociologists refer to the role that index-based contracts

From risks to second-order dangers in financial markets: Unintended consequences of risk management systems

The notion of risk is central to modern society, both as a productive and as a troublesome concept. On the one hand, risk refers to a situation of opportunity. Only those who undertake a risk, bear the uncertainties and face the potential adverse consequences, may gain the rewards. On the other hand, risk refers to fundamental uncertainty: at the time of risk-taking one cannot know for sure whether the opportunity concerned will be realised; in the worst case, the costs incurred might be greater than any benefit. Risk therefore increases the scope for both rational and seemingly irrational decisions: without the willingness to undertake a risk some opportunities may never be realised; the costs of an unsuccessful risky decision, however, may be intolerably high and may thus disqualify the whole enterprise in hindsight

Organised detachment: Clearinghouse mechanisms in financial markets

Bringing transactions to an end constitutes a crucial stage of market activity: the detachment between the counterparties engaged in a trade must be guaranteed. In financial markets, this operation relies on organisational technologies, such as clearinghouses, that can reach a high degree of sophistication. In this paper, we use financial clearinghouse mechanisms to explore how such detachment technologies are constructed. Based on several historical examples, our review shows that clearinghouse mechanisms developed on the basis of an increasingly IT-enabled organisational separation between the trading and clearing stages of market activity were a crucial factor that enabled clearinghouses to calculate the mutual obligations of the counterparties and perform the consequential steps. Our analysis goes on to reveal a paradoxical thread in the evolution of clearing: increasing informational and calculative capacity have lead clearing mechanisms to breach the separation on which their ability to operate was dependent - the boundary between trading activity and clearing processes. These findings shed a new light on the reflexive nature of IT-enabled market innovations and emphasise their role in re-introducing new forms of disorganisation back into contemporary financial markets.

Regulatory experiments: genetically modified crops and financial derivatives on trial

Experiments play a crucial role in contemporary policy-making, yet their political and epistemological dimensions have been neglected in studies of regulatory practice. This article offers an initial examination of the uses of experiments in regulation. It analyses two examples: the partial release of genetically modified organisms in the UK Farm-Scale Evaluations, and the unleashing of option contracts in the Chicago Board of Options Exchange. We analyze both cases in terms of the dialectic they institute between the ‘experimental gap’ created to observe these regulatory objects under controlled conditions, and the need to ‘project’ the experimental evidence onto the world at large. In our two examples, experiments fail to produce a final consensus or definitive certainty, but serve to translate conflicts into amenable forms of uncertainty. Regulatory experiments should thus be seen as tests on the governability of new objects, and should be open to further scrutiny by interested parties. Copyright , Beech Tree Publishing.

Who and What Really Counts? Stakeholder Prioritization and Accounting for Social Value

Research in stakeholder management has theorized extensively the prioritization of stakeholders as a key dynamic of firms’ value creation, but has paid less attention to the organizational practices involved in the process of deciding ‘who and what really counts.’ We examine changes underpinning managers’ prioritization of stakeholders and focus on how managers’ attention to salient stakeholders is represented and communicated in a firms accounting and reporting system. We study the emergence and development of Social Return on Investment (SROI): an accounting methodology intended to permit managers both to incorporate stakeholders’ voices and to communicate the social value created by the firm for those stakeholders. We find that the ability of SROI to account for specific stakeholders, thus categorizing them as salient for the firm, is shaped by managers’ epistemic beliefs and by the organizations material conditions. Our findings contribute to stakeholder theory by showing that the prioritization of stakeholders is not solely a managerial decision, but instead is dependent on the construction of an appropriate accounting and reporting system, as shaped by managers’ epistemic beliefs and by the organizations material conditions.

Towards a practical approach to responsible innovation in finance: New Product Committees revisited

The purpose of this paper is to highlight the potentials offered by New Product Committees for the development of responsible innovation in the financial services industry; and to provide grounds for policy recommendations. The paper takes the form of collective, interdisciplinary reflection and experience within the industry. New Product Committees can serve a practical approach to responsible innovation in finance.