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Moore's Law Vs. Murphy's Law in the Financial Journal Of Investment Management, Vol. 15, No. 1, (2017), pp. 17–38 © JOIM 2017 JOIM www.joim.com MOORE’S LAW VS. MURPHY’S LAW IN THE FINANCIAL SYSTEM: WHO’S WINNING? Andrew W. Loa Breakthroughs in computing hardware, software, telecommunications, and data analytics have transformed the financial industry, enabling a host of new products and services such as automated trading algorithms, crypto-currencies, mobile banking, crowdfunding, and robo-advisors. However, the unintended consequences of technology-leveraged finance include firesales, flash crashes, botched initial public offerings, cybersecurity breaches, catastrophic algorithmic trading errors, and a technological arms race that has created new winners, losers, and systemic risk in the financial ecosystem. These challenges are an unavoidable aspect of the growing importance of finance in an increasingly digital society. Rather than fighting this trend or forswearing technology, the ultimate solution is to develop more robust technology capable of adapting to the foibles in human behavior so users can employ these tools safely, effectively, and effortlessly. Examples of such technology are provided. 1 Introduction onto a chip seemed to double every year (Moore, 1965). This simple observation, implying a con- In 1965—three years before he co-founded Intel, stant rate of growth, led Moore to extrapolate an now the largest semiconductor chip manufacturer increase in computing potential from sixty tran- in the world—Gordon Moore published an arti- sistors per chip in 1965 to sixty thousand in 1975. cle in Electronics Magazine in which he observed This number seemed absurd at the time, but it was that the number of transistors that could be placed realized on schedule a decade later. Later revised by Moore to a doubling every two years, “Moore’s aCharles E. and Susan T. Harris, Professor, MIT Sloan Law” has been a remarkably prescient forecast of School of Management; director, MIT Laboratory for the growth of the semiconductor industry over the Financial Engineering; principal investigator, MIT Com- last 40 years, as Figure 1 confirms. puter Science and Artificial Intelligence Laboratory; 100 Main Street, E62-618, Cambridge, MA 02142, USA; [email protected]. Other affiliations, including all com- Technological change is often accompanied mercial relationships, are disclosed at http://alo.mit.edu/. by unintended consequences. The Industrial First Quarter 2017 17 18 Andrew W. Lo Figure 1 Illustration of Moore’s Law via transistor counts on various semiconductor chips from 1971 to 2011, which seems to double every two years (Source:“Transistor Count and Moore’s Law—2011 by Wgsimon”, CC BY-SA 3.0). Revolution of the 19th century greatly increased Some of the unintended consequences of finan- the standard of living, but it also increased air cial technology include firesales, flash crashes, and water pollution. The introduction of chemical botched initial public offerings (IPOs), cyberse- pesticides greatly increased the food supply, but curity breaches, catastrophic algorithmic trading it increased a number of birth defects before we errors, and a technological arms race that has cre- understood their properties.And the emergence of ated new winners, losers, and systemic risk in an interconnected global financial system greatly the financial ecosystem. The inherent paradox of lowered the cost and increased the availability modern financial markets is that technology is of capital to businesses and consumers around both the problem and, ultimately, the solution. the world, but those same interconnections also Markets cannot forswear financial technology— served as vectors of financial contagion that facil- the competitive advantages of algorithmic trading itated the Financial Crisis of 2007–2009. As a and electronic markets are simply too great for result, the financial industry must weigh Moore’s any firm to forgo—but rather must demand better, Law against Murphy’s Law, “whatever can go more robust technology, technology so advanced wrong, will go wrong,” as well as Kirilenko and it becomes foolproof and invisible to the human Lo’s (2013) technology-specific corollary, “what- operator. Every successful technology has gone ever can go wrong, will go wrong faster and through such a process of maturation: the rotary bigger when computers are involved.” telephone versus iPhone, paper road maps versus Journal Of Investment Management First Quarter 2017 Moore’s Law vs. Murphy’s Law in the Financial System 19 voice-controlled touchscreen GPS, and the kindly greatly increased the demand for financial ser- reference librarian versus Google and Wikipedia. vices. In 1900, the total human population was Financial technology is no different. To resolve estimated to be 1.5 billion, but little more than a the paradox of Moore’s Law versus Murphy’s century later—a blink of an eye in the evolution- Law, we need Version 2.0 of the financial system. ary timescale—the world’s population has grown to 7 billion (see Figure 2). The vast majority of these 7 billion individuals are born into this world 2 Moore’s Law and finance without savings, income, housing, food, edu- cation, or employment. All of these necessities Moore’s Law now influences a broad spectrum of today require financial transactions of one sort or modern life. It affects everything from household another, well beyond the capacity of the financial appliances to biomedicine to national defense, industry in 1900. Therefore, it should come as no and its impact is no less evident in the finan- surprise that innovations in computer hardware, cial industry. As computing has become faster, software, telecommunications, and data storage cheaper, and better at automating a variety of continue to shape Wall Street as a necessary part tasks, financial institutions have been able to of its growth. greatly increase the scale and sophistication of their services. The emergence of automated algo- rithmic trading, online trading, mobile bank- In fact, technological innovation has always been ing, crypto-currencies like Bitcoin, crowdfund- intimately interconnected with financial innova- ing, and robo-advisors are all consequences of tion. New stamping and printing processes—used Moore’s Law. to prevent clipping, counterfeiting, and other forms of financial fraud—led directly to the At the same time, the combination of population modern system of paper banknotes and token growth and the complexity of modern society has coinage. The invention of the telegraph sparked Figure 2 Semi-logarithmic plot of estimated world population from 10,000 B.C. to 2011 A.D. Source: U.S. Census Bureau (International Data Base) and author’s calculation. First Quarter 2017 Journal Of Investment Management 20 Andrew W. Lo a continent-spanning communications revolution beyond mere human capacity at all levels of the that led to the creation of the modern futures mar- financial system. One elegant example comes ket in 19th-century Chicago. And improvements from the options market. The Chicago Board to the ticker tape machine—symbolic of Wall Options Exchange (CBOE), the first of its kind, Street for over a century—made Thomas Edison opened just before Fischer Black, Myron Scholes, his early fortune. and Robert Merton published their foundational papers in 1973.1 However, the rapid growth 2.1 Technology and derivatives of the CBOE would have been impossible had financial professionals lacked an easy way to Not very long ago, most trades were made use the Black–Scholes/Merton option pricing for- through traders and specialists on the floors of the mula. As luck would have it, in 1975 Texas exchanges. The first electronic exchange, NAS- Instruments introduced the SR-52, the first pro- DAQ, opened in 1971, but it was originally only grammable handheld calculator, and one capa- a quotation system for the slow-moving over-the- ble of handling the logarithmic and exponential counter market. Most trades were placed over the functions of the Black–Scholes/Merton formula telephone and executed on the trading floor well (see Figure 3). into the 1980s. Today, however, nearly all trades on the major financial exchanges are consum- At $395 ($1,767 in 2016 dollars), the SR-52 was mated electronically. Moore’s Law made the floor a technological marvel that could store programs specialist obsolete, and trading volume increased of up to 224 keystrokes on a thin magnetic strip exponentially to meet this increase in trading that was fed through a motorized slot in the cal- capacity. If the modern financial system had to culator. Shortly after the SR-52 debuted, one rely on human specialists to manage even a frac- of the founders of the CBOE, a savvy options tion of this market volume, it would need a trading trader named Irwin Guttag, purchased one for his floor larger than a sports arena. teenage son and asked him to program the Black– The symbiosis between technology and finance Scholes/Merton formula for it.2 Within a year, has accelerated the pace of the financial markets many CBOE floor traders were sporting SR-52’s Figure 3 The Texas Instruments SR-52 programmable calculator, introduced in 1975 and used to compute the Black–Scholes/Merton option pricing formula by CBOE floor traders. Journal Of Investment Management First Quarter 2017 Moore’s Law vs. Murphy’s Law in the Financial System 21 of their own. By 1977, Texas Instruments intro- 25 5.E+09 duced a new programmable TI-59 with a “Secu- rities Analysis Module” that would automatically 20 4.E+09 calculate prices using the Black–Scholes/Merton formula. When Scholes confronted
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