Financial Engineering students learn what trading is really like
Master of Engineering students in ORIE's Financial Engineering (FE) program are steeped in mathematical and other technical topics in investment finance. But direct experience with trading the kind of securities they study is limited, as it is for students in other FE programs as well.
Levent Kahraman Econ '92 CEE '92 is bridging that gap with an innovative trading game he offered to ORIE financial engineers spending their third and final semester at Cornell Financial Engineering Manhattan (CFEM). The immersive semester, which the students spend doing projects and taking classes in the heart of New York's financial district, is the capstone of the program.
Last month, students spent an intense evening playing the game at the headquarters of KGS Alpha Capital Markets, where Kahraman is founder and CEO. While the game is in the tradition of "experiential learning" employed in ORIE's manufacturing courses in Ithaca, Kahraman developed it while building and managing a trading desk.
How it works
The game entailed specialization within six FE teams, which were located in different conference rooms at KGS Alpha headquarters. Team members played the roles of traders, structuring experts, sales and operations staff. The objective: servicing "customers" while making money by buying and selling securities to companies - "counterparties" - played by KGS staffers. The teams picked names for the firms they simulated.
"The game gave a very realistic balance of what can be done numerically and what requires the communication skills that are needed to do well as a trader," said Victoria Averbukh, Director of CFEM. "I think this game provided many with an eye-opening experience that topped the best trading internship. To my knowledge, ORIE's FE program is the only one that offers this kind of hands-on experience, thanks to Kahraman."
Kahraman developed the game after realizing that most trading games require periodically "freezing the (simulated) market" and introducing artificial "shocks" to challenge the students. To Kahraman, the result was comparable to a movie made from a good novel in which multiple possibilities are inherent on every page - like a novel, the actual market presents the trader with a lot of "noise" from which the true signal must be discerned by more than quantitative means. "Earlier trading floor games were too easy, because of the artificiality of the shocks," he noted.
A flood of emotions
For the students, playing the game brought on feelings of "joy and high adrenaline, it was a very emotional time," according to FE student Roni Yosofov, who graduated from Baruch College in New York City. "I felt confused at the beginning of the game", said Chenru Gong, who was born and raised in Shanghai, "but during the game I started to feel the pace and kind of felt the idea of how trading intuitions are generated."
"Team work and cooperation is very important," said Gong, who played for "CFSTrading." "Keep in mind that we only have one decision maker during the game, who is the trader. The sales people may have their own minds, but following the trader's idea is the key which led to success."
Communicate, communicate, communicate
While the team came into the game with computers and with spreadsheets they had developed to improve efficiency during the game, the actual play focused less on technical matters than on intense email and telephone communication between the teams and "banks," "insurance companies" and "hedge funds," each of which had different incentives to generate trading volumes and longer term relationships. In their own offices KGS Alpha staffers took on the roles and personalities of the buyers and sellers at these companies.
As the dynamics of the game continuously unfolded, students discovered the importance in a trading environment of using communication skills to engender trust.
"One of the downsides of learning in a classroom is that you don't necessarily develop the qualitative skills required for a real-world workplace," said FE student Nikhil Vaidya, a graduate of ORIE from Purchase, NY who played for "Rulloff's Trading." "The game was a great way to experience the types of problems that salespeople in the markets experience," he said.
For example "sometimes, the counter-party with whom we were trying to trade would become very annoyed" when his team quoted prices that were out of line with other market makers, Vaidya observed. "The ability to bounce back from a bad call or a burnt client and still try to work with them was a major factor in this game."
The information challenge of opaque prices
In Kahraman's game, determining what price to bid or ask was made more complicated because the players were not trading conventional stocks and bonds. Instead, the teams dealt in securities known as collateralized mortgage obligations, which are assembled from pools of mortgages.
These securities are representative of what are known as "structured products," created by broker-dealers to meet specific needs of investors which cannot be met from the standardized financial instruments available in the markets. Unlike stocks, the market for such securities is somewhat opaque, so traders must discover prices through communication and analyze them through math.
"Most trading simulations I had played in school and at my first employer looked a lot like stock trading, with transparent pricing," said Chris Vasil M.Eng. '07, who was an FE student prior to the expansion of the program to incorporate a third semester in Manhattan. Vasil now works for KGS Alpha and played one of the "hedge funds" in the game. This game "is so different from any other trading simulation, and a good reflection of how structured products work," he said.
"Due to the information disadvantage, it is extremely difficult to make money while balancing your risk exposures," said Vaidya. "This game made me realize how important it is to have an informational edge in today's competitive financial market."
Yosofov's team, "Prime Capital Trading," won first place with a profit of two million dollars and accolades from KGS Alpha for the best communication with clients. "CFSTrading" came in second. As for "Rulloff's Trading," Vaidya said his team, which came in third, "didn't hit our stride until the third of the three trading periods. The result was absolutely important to us, but at the end of the day it was a game, and we definitely benefited from the experience and tried to have fun."
Movies show that "trading and Wall Street are all about easy money, big cars and great life," said Yosofov, "making money and having fun all day. But after playing the game for just 2 hours, I knew that wasn't true, and that I won't be able to go out and have fun after working for 12 hours a day in such a stressful environment. However the exciting environment is very addictive," he added.
At the end of what Gong called an "intense and stressful" experience, many of the students wanted to continue playing, according to Averbukh, "because they now understood what was required to succeed."
A strong interest in Cornell financial engineering
Kahraman has "a strong commitment to Cornell," which he has expressed not only through organizing the game but through spending "a lot of time talking to students about the harsh realities of real life in the securities industry," he said. He points out that there are relatively few purely quantitative trading jobs among the thousands of jobs available to financial engineering graduates, and for these jobs, "knowledge of the mathematics of the widely-used Black Scholes formulation is not enough."
As a student coming to Cornell from Turkey, Kahraman learned the importance of understanding American business culture. "Watch old episodes of 'The Brady Bunch' and NFL football," he tells students, to see how to develop a set of shared experiences with other people in the U.S. "Cornell students already have what it takes vis-a-vis intelligence and integrity. What some need to work on more than anything else is the ability to connect," he said.
Kahraman's interest in Cornell FE extends to employing its graduates - four students, including three from ORIE's Financial Engineering program, will join his 130-employee firm in 2013. "We are extremely happy with the students we are getting from Cornell," said Kahraman. "This should be the beginning of a beautiful relationship."