Calculating risk has quickly emerged as the newest “low latency” financial application on Wall Street. And with good reason. In today’s volatile markets, measuring risk in near-time is simply not fast enough. The firms of tomorrow will need to invest vast sums in the technologies that help them manage ever-sophisticated risk management requirements.

Larry Tabb Founder & CEO TABB Group

The free and easy days of the capital love-fest are over. PDAs that once vibrated non-stop with the latest capital optimization structures have gone silent and only come to life when warning of the latest victims of the liquidity crisis. And bankers that were once willing to take calls anytime, anywhere, now seem to be in meetings, traveling or away from their desks all day long.

So where have all the bankers gone? It’s simple really – they are shuttered up in conference rooms re-evaluating internal policies that allowed the subprime mess to occur. But it is not only isolated in subprime, mortgage or asset backed divisions. The liquidity crisis emanating from the subprime meltdown has permeated the very fabric of most securities firms and the focus has now turned to predicting and avoiding future calamities.

To help prevent future crises, firms are beginning to re-evaluate risk management systems that were supposed to provide early warning signals of impending market stress. Measuring yesterday’s risk has become an exercise in futility. In today’s volatile, fast-moving market, firms need to be able to measure risk in real-time. Near-real-time, end-of-day, or overnight risk measurement is simply not acceptable. Instead, firms need to have systems that measure risk across diverse business lines operating 24 hours a day, 7 days a week, in disparate regions around the world.

All of this will take power. Not just the power to make decisions and changes to long-standing procedures but also the power to measure, to compute, and to infer how uncorrelated risks become correlated. Investment in hardware, software, and processes that can measure and manage risk are just beginning to emerge, with future spending expected to increase sharply.

Not surprisingly, Wall Street firms are dusting off 2008 budgets that were put to bed prior to the August rout and frantically increasing spending for technology that enables risk systems to properly function. They are re-examining budgets intended not only for the latest and greatest in vendor software offerings, but also for hardware that is powerful enough to run complicated risk management calculations across vast financial portfolios.

Risk management systems running simultaneous regression analyses, multiple Monte Carlo simulations or stochastic optimization models across global portfolios of equities, derivatives and fixed income instruments require significant computing power. Many firms will quickly find that existing infrastructure may not be up to the task. Purchase orders can be expected to quickly follow.

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Filed under: Issue 4 - Winter 07