Market Practitioners & Industry vs. Academic Research – Why the Gap?
There are several key reasons for the persistent gap between market practitioners in the finance industry (e.g., traders, portfolio and risk managers) and academic researchers.
We’ll explore these gaps in this article.
Key Takeaways – Market Practitioners & Industry vs. Academic Research
- Real-world trading challenges often outpace academic models, as markets are too complex and dynamic to be fully captured by the simpler theoretical frameworks used in academia.
- The most valuable innovations typically come from experienced practitioners who can bridge quantitative theory with practical market realities.
- Industry knowledge tends to flow slowly through job changes.
- This creates a significant lag before academics become aware of newer practices.
- Traders should be cautious about over-relying on academic models without understanding their limitations in real market conditions, just as academics need to be aware of how their theoretical models miss the mark in terms of practical realities (e.g., liquidity, market depth, bid-ask spreads, and other market microstructure issues).
- Collaborating with academics or pursuing interdisciplinary knowledge can provide unique insights, potentially leading to competitive advantages in trading.
Different Motivations and Incentives
The fundamental driver of the gap is that industry practitioners and academics are motivated by different goals and incentive structures:
Industry practitioners
Industry practitioners (traders, portfolio managers, etc.) are primarily focused on generating profits, managing risk, and developing practical strategies that work in real-world market conditions.
Their success is measured by financial performance and the ability to handle complex, dynamic market environments.
Academic researchers
Academic researchers, on the other hand, are incentivized to publish papers, contribute to theoretical knowledge, and advance their academic careers.
Their success is often measured by the number and impact of their publications, rather than practical applicability.
This divergence in motivations leads to a natural drift between the two groups, as they pursue different objectives and prioritize different types of knowledge and skills.
Lack of Necessary Interaction and Funding Pressure
Unlike some other fields, such as engineering or computer science, quant finance research in academia doesn’t typically require expensive equipment or substantial industry funding.
This lack of funding pressure means that academics in finance don’t have the same incentives to maintain close ties with industry practitioners.
Also, finance is often a highly guarded profession, driven by the fear that proprietary information could be taken and widely used.
So, closer ties between industry and academia aren’t necessarily practical.
In contrast, fields like engineering often require significant resources for research, creating a natural bridge between academia and industry through funding relationships.
Historical Context and Culture
The gap in finance may be partly due to historical factors.
Computing theory and practical application emerged within the academic-military-industrial complex during the Cold War, with frequent crossovers between these sectors.
Although that era has passed, it left behind a culture that still influences the field today.
In contrast, quantitative finance developed primarily within the private sector, in banks, and in buy-side investment firms.
This has created a culture where the flow of information is predominantly one-way, from industry to academia, with limited reciprocal exchange.
Proprietary Nature of Industry Knowledge
The finance industry’s approach to intellectual property and knowledge sharing contributes to the gap.
Patenting is uncommon in finance, with knowledge typically shared through word of mouth.
This works within the industry since it’s a small, interconnected world with people moving through it via changing jobs or firms.
Even in the context of those changing jobs, employees in investment firms are commonly siloed into specific groups such that they don’t get a complete picture of what’s going on, which makes it more difficult to spill proprietary information.
Naturally, markets are adversarial and disclosing that information is considered bad for business.
This informal, closed system of knowledge sharing makes it difficult for outsiders, including academics, to access the latest information and understand the most pressing issues in the industry.
The lack of patents and public disclosures further widens the information gap.
Disconnection from Real-World Problems
Academics often struggle to identify and focus on the most relevant problems facing the industry.
Academics generally lag years behind in identifying relevant questions in financial markets and may lack curiosity about real-world issues because it doesn’t affect them.
This disconnection leads to academic research that may be theoretically interesting but lacks practical relevance.
Academics may focus on narrow topics that are easier to publish but have limited real-world application.
Complexity and Dynamism of Financial Markets
The always-changing nature of financial markets and the complexity of real-world trading environments are difficult to capture in oversimplified academic models.
Accordingly, academic research typically fails to address the real-time challenges of portfolio management.
This complexity makes it challenging for academics to develop models and theories that accurately reflect the nuances and dynamics of real markets, further widening the gap between theory and practice.
For example, if traders deduce that there’s an alpha stream having to do with mispriced tail risk in options markets, by the time non-market practitioners gain wind of such an advantage markets will have more efficiently repriced this risk.
Diverse Roles Within the Industry
Even within the finance industry, there are varying levels of disconnection from practical realities:
- Quants producing models may be removed from reality unless guided by knowledgeable trading heads.
- Risk management professionals often miss dynamic market issues due to their distance from front-office operations.
- Traders may either over-rely on models without understanding their limitations or be overly skeptical of quantitative approaches.
This diversity of roles, training, backgrounds, and perspectives within the industry itself adds another layer of complexity to bridging the gap with academia.
As we wrote in a different article, trading, investing, and finance blends elements of economics, business, mathematics, statistics, probability, programming, psychology, history, and other disciplines into one.
Innovation Flow and Time Lag
Innovations in finance often originate from experienced practitioners:
This type of research isn’t usually published, and slowly seeps through the industry as people change jobs.
This pattern of innovation creates a large time lag between the development of new ideas in the industry and their eventual recognition or study in academia.
Lack of Interdisciplinary Understanding
Most valuable innovations often come from individuals who can bridge the gap between theoretical models and practical realities.
The rare exceptions are typically complex derivatives traders or portfolio managers with strong practical quant backgrounds.
They operate in both the abstract world of models and the realities of markets, often leading innovation.
However, such individuals are relatively rare, as they require a unique combination of theoretical knowledge, practical experience, and the ability to translate between these two worlds.
Publication Pressure in Academia
The academic focus on publishing can sometimes detract from addressing relevant, practical issues.
Once the need to publish comes in, focus is often lost.
This pressure to publish frequently leads academics to prioritize topics that are more likely to be accepted by journals, rather than tackling the complex, messy problems that practitioners face daily.
Implications and Potential Solutions
What can be done to bridge this gap?
Some ideas:
Fostering Collaboration
Encouraging more collaboration between industry practitioners and academics could help bridge the gap.
This might involve joint research projects, industry sabbaticals for academics, or visiting practitioner roles in universities.
However, the divide remains and is difficult to close.
Aligning Incentives
Academic institutions could consider modifying their reward structures to place greater value on practical relevance and industry impact, alongside traditional metrics like publications.
Improving Knowledge Transfer
Developing more effective channels for knowledge transfer from industry to academia could help keep researchers informed about current challenges and innovations.
Interdisciplinary Education
Encouraging finance students to gain practical experience and teaching practitioners about academic research methodologies could help create more individuals capable of bridging the gap.
Industry-Sponsored Research
While not as important as in other fields, increased industry funding for academic research in finance could help align research agendas with practical needs.
Open Innovation Initiatives
The finance industry could benefit from more open innovation approaches, sharing non-sensitive information more freely to stimulate academic engagement.
But, as mentioned earlier, finance tends to be a heavily walled-off profession due to the fear that proprietary information will be taken and broadly applied.
Focused Conferences and Workshops
Organizing events that bring together academics and practitioners to discuss current challenges and recent innovations could help with better understanding and collaboration.
Revising Academic Curricula
Ensuring that finance education includes significant exposure to real-world problems and case studies could help prepare future researchers to engage more effectively with industry issues.
Conclusion
The gap between market practitioners and academic researchers in finance is a complex, multifaceted issue rooted in different incentive structures, historical development patterns, and the unique characteristics of the finance industry.
Bridging this gap will require concerted efforts from both sides, as well as structural changes in how research is conducted, shared, and valued.
With greater collaboration and aligning incentives, it may be possible to create a more symbiotic relationship between academia and industry.
This could ultimately lead to more relevant research and more theoretically grounded practical innovations.
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