Pricing Risk, Governing Risk-Taking: Trust, Modelling and the Cultures of Credit Risk Evaluation in Commercial and Investment Banks

Speaker: Dr Taylor Spears # Sociology, University of Edinburgh

22nd Feb 2016

15:30 - 17:00

Staff Room, 6th floor, Crystal Macmillan Building (University of Edinburgh, George Square)

Trust in economic exchange was a major focus of the ‘new’ economic sociology that emerged in the 1980s with its focus on the ‘embeddedness’ of economic relations in social networks, but one that has attracted comparatively little attention within the Social Studies of Finance. How, for instance, can a bank’s managers trust that its traders are acting in line with the interests of the bank’s shareholders? This paper addresses this question in the context of large commercial and investment banks whose traders ‘make markets’ in interest rate derivatives. I argue that banks increasingly seek to control the activities of traders by building financial modelling infrastructure capable of assigning market prices to – and ‘charging’ employees for – the costs, benefits, and risks that their actions engender to the wider firm. I do so by examining the historical development of a cluster of calculative practices used within large banks to explicitly ‘charge’ derivatives traders for the extent to which their activities expose the bank to ‘counterparty risk’: the risk that a bank’s derivatives counterparty may go bankrupt and thus be unable to make good on its required payments. Drawing on fifty interviews with financial mathematicians, economists, and derivatives pricing specialists (i.e. ‘quants’) and a large corpus of technical documents, I examine why explicit pricing of counterparty risk emerged as the preferred solution to the problem of governing risk-taking by derivatives traders over various alternatives, and how each group of banks approached the problem of pricing this risk in line with a particular ‘culture’ of credit risk evaluation shaped by banking regulation.

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