Is the Recent Banking Crisis an Overreaction? Vasant Dhar Weighs In on the Collapse of SVB
CDS Associated Professor of Technology, Operations, and Statistics Vasant Dhar recently wrote an editorial featured in Yahoo Finance, evaluating the reaction to last month’s Silicon Valley Bank (SVB) financial meltdown. In his article “SVB was a hedge fund in disguise–and the banking crisis is an overreaction”, Vasant proposes that investors have overreacted to the bank’s recent implosion, which marks the second-largest bank failure in US history.
“If we compare the relative performance of Silicon Valley’s stock to that of JP Morgan and Bank of America since 1993, its market value rose 250-fold until the market’s peak on Nov 3, 2021, relative to 11-fold for JP Morgan and three-fold for Bank of America,” Vasant explained. The question this begs is: “if banks borrow and lend at relatively the same rate, how could a bank outperform an industry leader by a factor of 20?” Vasant suggests that there’s a larger lesson to be learned here for investors.
In his NYU Stern course “Robo Advisors and Systematic Investing”, which is based on his experience operating a machine-learning-based hedge fund on Wall Street, Vasant teaches students how to leverage algorithms to exploit mispricing opportunities in the stock market. So how can algorithms recognize overreactions? In a recent class assignment, one of his students presented “a simple volatility-based formula to categorize overreactions and to implement a simple counter-trend system”. She applied this approach to JP Morgan’s performance since 1993, and her findings demonstrated “impressive risk-adjusted performance” for JP Morgan and Bank of America. The takeaway is that the source of market turmoil mispricing is often detached from the turmoil source, which presents potential opportunities for investors. Furthermore, reversion algorithms such as this can work across the market because of this tendency of investors to overreact.
Vasant goes on to point out that during COVID and the Great Financial Crisis, the VIX market volatility index was in the high 80’s. Recently, it’s been in the mid-to-high 20’s. Though the data seems not to suggest it, we have overreacted, which is at least in part due to the media frenzy surrounding it. Ultimately, Vasant asserts that algorithms such as this should continue to be useful, but investors should still be vigilant in identifying assets with “risks similar to SVB’s that the market has not yet repriced.”
We recommend listening to episode 33 of Vasant’s podcast Brave New World, where he chats with Stern colleague Aswath Damodaran, who is Kerschner Family Chair in Finance Education and teaches corporate finance and valuation. The conversation covers what’s needed for successful investing and more.