The Cost of Having It Now
Associate Professor of Finance
In today’s markets when an investor wants to buy or sell, the deal will go through right away. That’s because intermediary organizations, such as banks and brokerage houses, are willing to hold securities or other financial instruments until they can be turned around so there’s always an immediate buyer or seller.
There’s a cost to this service, of course, and it can be a very lucrative business for those who provide it. Now George Chacko, Professor of Finance at SCU’s Leavey School of Business, has come up with a model to determine what the service is worth.
“Everybody understands what’s going on in this sort of transaction,” he said, “but nobody’s modeled it before. That’s what we’ve tried to do.
Chacko is first author of a paper, along with two colleagues from Harvard Business School, Jakub W. Jurek and Erik Stafford. Called “The Price of Immediacy,” it has been accepted for publication in the June 2008 issue of the Journal of Finance.
"Everyone understands this sort of transaction, but nobody's modeled it before."
—George Chacko, Associate Professor of Finance
The concept of business intermediaries extends through all of commerce, he said. An example everyone can understand is the grocery store. “If you go to the store to buy a tube of toothpaste,” he said, “you’re paying a premium to the store for buying the toothpaste and holding it until you come in for it.” Customers are willing to pay that premium because of how inconvenient it would be for them to deal directly with the manufacturer and wait for delivery.
But it’s hard to place an objective value on that premium, which is one of the reasons the same tube of toothpaste sells for different prices at different stores.
Several years ago, when he was at Harvard Business School and working at State Street Bank, a leading Boston-area financial institution, Chacko got to thinking about the lack of a formula to determine what the intermediary holding service is worth. It’s a question he’s still very much interested in as managing partner of a hedge fund, 6S Capital based in Zurich.
“This was something that has always been done by hunch and experience, but I wanted a more formal and rigorous way of doing it,” he said.
Chacko and his associates focused their research on the financial markets because of their transparency. “You can see all the prices and know exactly what the buyers and sellers are doing,” he said. However, the formula they came up with can be used in a far broader range of businesses.
Developing the formula took years and involved a number of dead-end investigations. There are two risk factors involved — how long is the product held and how much does its price fluctuate — but those had to be weighed against a number of other considerations in varying degrees to come up with something that works.
In the end, the formula they developed yields similar results to those generated by experienced professionals who are relying on hunch and experience. The value of that to companies in this line of work is that they can rely more on the formula and not have to pay high-priced professionals to do the educated guesswork. Chacko said the formula could be put to wide use in the financial industry.
“I think it can be used by financial institutions — banks, insurance companies, brokerages, hedge funds — that are involved in buying and selling,” he said. “Everyone can make use of this process to run the business more quantitatively and have more accurate financial measurements.”