Goldman 2006 Student Project

Sept. 12, 2006 -- For three MSCF students, what started as a class project turned into a long-term working relationship with industry professionals. When Kaiping Chen, Rachel Duncan, and Eric So first met to discuss topics for an open-ended Linear Financial Models course project assignment, they weren't sure in what direction to head. Then it struck them that there is a world of finance professionals out there faced every day with interesting research questions motivated by real-world issues. After a few e-mails and phone calls, they found an interested party in Goldman Sachs Asset Management (GSAM), who had sent two representatives from its Quantitative Strategies group to participate in the MSCF Speaker Series a few weeks prior.
 
GSAM asked the students to replicate and interpret the findings of a working paper published nine months prior on idiosyncratic volatility and the cross-section of expected stock returns. [1]  The findings in this paper provide empirical evidence supporting Robert Merton's 1987 assertion that in a capital market equilibrium model with incomplete information, expected returns are positively related to idiosyncratic risk and size. In addition to breaking from the widely accepted Fama-French three-factor model in which expected returns are negatively related to size, these findings point to a fourth significant factor ­-- idiosyncratic volatility.
 
The students quickly realized that replicating these findings was going to take longer than the four weeks they had left in the mini-semester. They were able to submit the first step, cross-sectional regression of returns on the Fama-French factors, as their Linear Financial Models project. Eric and Kaiping then went on to complete the second step, estimation of idiosyncratic volatility and cross-sectional regression on all four factors, and submitted their findings to GSAM in April. In completing this project, the students put to practical use the financial theory, regression techniques, time series estimation methods, and programming skills they had gained from their MSCF course of study that year.
 
The culmination of their efforts was an invitation to travel to New York on September 1st to present their findings to GSAM's Quantitative Strategies group. The presentation gave GSAM the opportunity to get a fresh perspective on a research question of great interest to them and gave the students the opportunity to engage with research professionals in the context of a working relationship.


[1] Fu, Fangjian, "Idiosyncratic Risk and the Cross-Section of Expected Stock Returns" (June 2005). EFA 2005 Moscow Meetings Paper: http://ssrn.com/abstract=676828