The Harbus sat down with Professor Alan McCormack to answer your burning questions about the Financial Market Simulator (FiMSim). This conversation has been edited for length and clarity by the author.
How did FiMSim become part of the FIELD curriculum? What was the development process like?
Professor Josh Coval has had FiMSim in his EC course for a few years, so we thought it would be unique to not only have students build businesses in FIELD 3, but also to actually have to evaluate and trade in those businesses.
You’re getting two perspectives; you’re trying to put something together, but you’re also looking at and evaluating 15 other businesses. This is a very unique aspect of FIELD 3 when compared to courses in other schools.
At an early stage, we decided to take the essence of the FiMSim and use it in FIELD 3, but the existing solution couldn’t scale to 900 students. It had to be redesigned to handle ten markets, 15 stocks each, 90 traders per market.
We started working last summer with IT and had an early beta test around Halloween with a bunch of EC students. We came up with little short descriptions of fictitious FIELD 3 businesses just so we could have the ECs trade as if they were first year students. Some of the business ideas were actually quite good!
In the first beta test, a lot of things went wrong. We found errors in some of the algorithms and issues with communicating over Wi-Fi, but then we knew exactly what to work on. In November and December, the IT guys added new functionality, and it’s been an amazing success.
If you look at the volume on Launch Day, there was a moment at 1pm when everyone was like, “Come on, open the market!” We’d never had anything like that happen, 900 people trading simultaneously when the clock hit one o’clock. That was a huge win, because everything performed amazingly well. We were never entirely sure what was going to happen.
We’ve all heard that some changes were made to FiMSim after the first trading day. What happened, exactly?
In the first trading session, we had unconstrained trading and it was possible for you to short stocks substantially. If they fell, this created lots of buying power for you to continue to short them again. Just 1-2% of the students adopted these tactics, but it meant that with the stocks they were looking at, the impact on the price was larger than the average student. People who understood leverage really took big bets.
In the real world, you might get a margin call or a brokerage might say you need to close out some positions or risk getting liquidated. In FIELD 3, we didn’t have a mechanism to actually do that, so that’s why we made these small changes to constrain the volume of shares. If you think a business is really valuable or not valuable, 2000 shares is plenty!
This reflects reality in that in a real trading environment, you’re not allowed to take on unlimited amounts of risk. In the first session, of those who took on these huge amounts of risk, about half got hammered and half made a lot of money – multiple millions in one session. Nobody did anything illegal, they just adopted extreme positions that were allowed by the software, so we responded to that.
Has there been a marked change in investor behavior from one trading window to the next?
Participation rates have varied, with 850 out of 900 active traders in session one, down to around 600 in session two, then up to around 870 on Launch Day. I think there was a lot of energy and excitement around it because it became a social experience within section and you had real-time feedback on your own company, which you hadn’t had previously. It created great dialogue.
For example, there are two teams in different sections offering a gym laundry service. Both of those teams started with the same stock price, $201.38, which is kind of weird, and they traded very similarly, even though they had different sets of investors. They could see this happening live, which they could never see before.
Also, what we did see in the third session is trading strategies became a little more common. We acknowledge that there is an asymmetry of comfort with trading, but you’re all taking Finance 2 and you’re discussing financial markets and liquidity. I think people came up to speed and got really savvy through this experience.
The majority of students just bought a few stocks in session one, but by the third session, students realized that you can trade much more aggressively, borrow money to make a bigger bet, hold short positions, etc. Ultimately, though, FiMSim was created to allow students to express their opinions about the value of these stocks. If you look at the top performing stocks, they look like businesses that have a future.
Have you noticed any interesting or surprising trends in investor behavior?
One of the interesting things to us is that the financial market is designed so that the average stock price will be $100. What we observed, however, is that the average stock price in each section is not $100, so there are arbitrage opportunities left on the table.
In one section, someone developed an Excel tool to be able to calculate what the arbitrage opportunity was and then trade upon it, so that section has average stock price of $100.08. By contrast, the average price of Section H stocks is $76, so there was an instant 30% gain for any investor in Section G who could work that out, but it didn’t happen.There is a counter-example, in another section, in which the average stock price is about $127, so a shrewd investor ought to have sold all of the stocks.
Why is this? It could be that it’s just hard to actually exploit that arbitrage opportunity. There’s not an easy mechanism to do that, so perhaps it’s just the burden of having to make 15 trades to get that arbitrage. If we had an ETF that allowed you to buy or sell a basket of stocks, we could imagine that the market would instantly be more efficient.
We had several emails over the course of the simulations where students who realized what was going on wanted to trade more aggressively to take advantage of arbitrage opportunities but had run out of buying power. They asked if we could give them more credit, but the answer was always, “No.”
How accurate a predictor are FiMSim stock prices of future business success?
Th financial market at its heart is more of a prediction market. What you’re trying to do is assess how the judges are going to rate these businesses, and there’s a lot of uncertainty over that process.It remains to be seen how well it predicts what judges think are valuable companies.
We created it originally as a way to give teams early information on what a cross-section of investors would think of their business ideas. A constant theme in FIELD 3 and TEM is the need for entrepreneurial ventures to be able to get really early feedback on their ideas, although the most important feedback is from customers.
In the early days, investors don’t have a lot of information to go on, so you could imagine that the prediction market may not be super accurate, but it provides some information. The FiMSim was speaking quite loudly about some stocks, so it’s important for teams to consider what best serves them from a learning perspective going forward. There were nine “failed business track” teams on Launch Day, and we anticipate that some more teams will now acknowledge that it’s probably better for their learning to step back and reflect at this time rather than push forward.
It’s worth noting that when the judges do come in for IPO Day, they won’t know your stock prices. They’ll be giving an independent view, which will be fascinating to see on May 14. When this all started, there was no reason to believe that our 150 teams would be any different from start-ups in general, and the hit rate is pretty small for start-ups. It wouldn’t be surprising if the judges rank relatively few teams as being long-term viable.
What changes are you going to make for next year’s class?
We learned some interesting lessons so far, regarding press releases and how to structure interactions with the financial market. What new information makes sense to present to investors before you trade? The way we did Go Day and Launch Day required big chunks of time, but that led to much higher participation in FiMSim. Also, the investor relations sites should have links to websites, team logos and other things, but there just wasn’t enough time this year.