In a Harvard Business School classroom, students in the Dynamic Markets class may have one minute to make a decision in a pressure cooker one called "the most stress I've experienced in ten years."
It's margin call time in a real-world market investment computer simulation called upTick. Students whose investments have fallen below margin requirement levels are being told they have sixty seconds to liquidate part of their portfolio to cover—effectively locking in a loss—or gamble that their investments will recover before insolvency is declared.
"Many students find this minute—and the decision of whether to ride it out and hope for a recovery or to blink and 'puke their position' (pardon the phrase but it's how actual traders describe it)—to be an extremely harrowing experience," says professor Joshua Coval.
And that's the point. Real life money managers face such stress frequently, but it's a hard thing to teach in a classroom.
Each year, thousands of business school students enroll in courses on finance. Their sights set on a career in money management, they dutifully study theories such as the Law of One Price and apply their knowledge to hypothetical situations in classroom discussion. It's not a bad way to learn, but Coval and colleague Erik Stafford felt the need for a classroom tool that would more effectively communicate the dynamic nature of their subject.
The theory predicts the endpoint. It doesn't tell you in practice how you're going to get there. —Erik Stafford
"Competition is at the heart of many of the concepts in finance," says Coval. "The problem you face in the classroom is that the setting is very static. You have a case and a blackboard to show how the competition plays out and reaches equilibrium."
The pair conjectured they would get a much more natural and powerful way of reaching a conclusion by creating a setting where the students actually go through some kind of competitive process to reach the same outcomes they would otherwise be studying in a teaching note.
The result: upTick—a software simulation program that enables a classroom full of students to participate in situations that demand the sort of real-time decisions made in real-world markets. Simulations mirror historical (but disguised) examples, such as Apple Computer's stock market performance in the early 1990s.
Students act on information pulled from actual accounting statements, earnings forecasts, and macroeconomic data, revising and forming new strategies as data becomes available. At the same time, they can take into account the decisions of their competitors.
"Most finance assumes complete, incredibly intense competition," Stafford notes. "But students don't have much context to evaluate what that really means and to understand what types of frictions prevent markets from being competitive."
"It's not so much that the students have a hard time believing that the real world is a competitive one," adds Coval. But much of finance theory can only be communicated in the classroom by making certain assumptions about the similarity of investors—that they all have the same information, for example, and the same tolerance for risk.
"This is clearly not the case, although the real world outcome ends up being quite close to the prediction of a model that assumes everyone is identical," he says. "But students aren't going to take your word for that. They'll believe the assumptions are based on an academic fantasyland. So it ends up being very powerful when they see these predictions do in fact bear out in a classroom setting."
The pair has used upTick over the past two years in their Dynamic Markets classes. Other schools including Princeton, Cornell, and Columbia have adopted the program. It is not currently available for purchase, although that may change. "This is a work in progress. There are always challenges because we continue to innovate and try new ideas," Coval says.
Over the course of a simulation, students input their decisions on networked computers; once trading is halted, the program automatically generates a slideshow summary of individual and overall performance. The graphs of prices, positions, profits, and risks at individual and aggregated levels offer a number of jumping-off points for discussion, and students can't hide behind 20/20 hindsight—their original choices are there for all to see.
An unexpected result from the program's introduction offers a good example of how upTick works.
We have some classes where students live through a pretty harrowing experience. —Joshua Coval
"We almost didn't run the first simulation because we figured everyone would easily see ahead to what would happen and that there'd be no trading at all," says Coval. "Anyone who purchased the right to be a liquidity provider would lose a ton of money, and we'd be done." In fact, just the opposite occurred. "We ran it a few more times with the same results before the market collapsed and reached the predicted equilibrium," Coval says. "And it's worked that way in every class, including the other schools that use upTick."
"If it had been a lecture, we would have said what would happen, the students would have nodded, and we would have moved on," adds Stafford. "The theory predicts the endpoint. It doesn't tell you in practice how you're going to get there. We have a logical mathematical model that predicts that point, and students can understand that. But when you force them to really participate in getting there, it's a very different path."
A Lasting Impression
According to Coval and Stafford, taking that path can leave a deep impression.
"We have some classes where students live through a pretty harrowing experience," says Coval. "The market moves against them, and they have to decide whether they're going to assume a lot of additional risk in the hope of getting back to even. Or perhaps if things continue to go against them, they'll be irreparably harmed in their ability to be successful in the course. They live through that, and we have students who say they remember it vividly even a few years later."
Experiencing that pain in the classroom can't be fun, but upTick does give students an appreciation for the consequences of competition.
"It makes you think beyond your own actions to how everyone is solving a problem," says Stafford. "You accumulate experience alongside the theory. Getting those lessons together, I suspect, is very valuable."