A California-based software startup is beta-testing risk management software for advisors based on agent-based modeling. Founded by long-time risk expert Rick Bookstaber along with CEO Govinda Quish and COO Jeff Roush, Talagent Financial is seeking to differentiate its software by treating risk as an ongoing narrative, not simply a risk tolerance number or a stress test based on historical data.

Most institutional risk stress-testing software, including BlackRock’s Aladdin, Barra and Risk Metrics, rely heavily on market behavior over the past two years. Quish and Roush try to look at second-order effect.

According to veteran advisors like Kochis & Fitz founder Tim Kochis, the program is trying to make the conversation about investment objectives and risk tolerance “more dynamic and richer.” Kochis is a consultant to the firm.

The founder also is the startup's chief scientist, Rick Bookstaber, an M.I.T. Ph.D. and chief risk officer of the $125 billion University of California pension system. After the financial crisis, Bookstaber spent several years at the U.S. Treasury. Prior to that he held a number of senior positions on Wall Street and was chief risk officer at Morgan Stanley.

Bookstaber has utilized agent-based models at Talagent. “These models are in use in areas ranging from understanding traffic flows to anticipating the potential stampedes from panicking crowds,” Bookstaber and Kochis wrote in a recent paper.  “Not surprisingly, they find an application with markets, too.”

When it comes to markets, some investing agents trade frequently based on recent price momentum while others, like most RIAs, are slower and “adjust based on deviations from an asset allocation goal,” their paper continues. Moreover, some investors leverage themselves and then deleverage very quickly when confronted with market shocks that push them close to their margin limits. As investors discovered during the financial crisis, leverage and deleveraging can magnify margin movements dramatically.

Embedded in the software is the notion that an investor’s risk tolerance is dynamic. Some clients present themselves as very risk averse. But after discussing their financial goals with an advisor, they may agree the client needs to take on more equity risk, Kochis said, adding a key goal is helping investors “understand the probability set.”

Liquidity factors prominently into gauging market risk. When equities swooned around the world last December, Quish said liquidity remained high, making the likelihood of cascading asset sales fairly limited.

So where does the Talagent Financial team see as the major risks today? There is “increased policy uncertainty and geopolitical risk,” Quish said. “The range of potential outcomes is now widening.” 

Among their conclusions: staying close to home might be the safest strategy.

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