David at Deus Ex Macchiato has had a pretty capital idea for testing out bank regulation — and a pretty timely one, with Basel reforms in play.
In short, turn it into a game:
There are two classes of players. The first class is the bankers: they define trading rules for an individual bank. They can’t dictate transactions; rather, they write rules which determine what transactions a bank will do, depending on market conditions. There can be as many bankers as there are banks, but balance sheet size and initial capital is allocated randomly to players at the start of the game subject to plausible distributions.
The game proceeds by the simulation being run through time; this is then repeated many times. The banker’s payoff is the average of the positive part of the bank’s profit averaged across all the simulations. So, like the real world, these guys score higher if their banks make a lot of money in a variety of conditions.
The second class of players is the regulator. This player rewrites the rules that the banks must obey. Their score is based on the number of bankruptcies and both the volatility and level of credit supply: basically they score highly if there are no bank failures and credit grows slowly but steadily.
David makes the obvious comparison, so we don’t have to (link ours):
It might not be a popular as world of warcraft, but I bet if you got the user interface slick enough, quite a few financial services people would play, and all that expertise could be used to improve the capital rules. The key point is that even if you don’t believe the results of the simulation are realistic, having something that suggests financial system vulnerabilities on the basis of actual dynamics and attempted gaming of the system could be quite useful.
Probably fewer Orcs involved, though.
Honestly, we’d love this as an alternative alongside the stress tests, largely because this game — like any game — would have to deal with an aspect they often overlook: cheating. The key bit of this game’s rules also appears to be that they’re adaptive in time and emergent from the actions of other players, mitigating the ludic fallacy.
On the other hand — there’s the problem that this game could get forbiddingly complex.
For a start, you could fit in at least one more broad class of player if the game is about bank capital — shadow bankers — plus provisioning for regulatory capture defection between classes. Don’t get us started either on whether regulators could really rewrite rules as they see fit, or whether we’d need ‘politician’ and ‘voter’ classes too.
Do you see where we’re going with this? It could all get a bit Borgesian:
…In that Empire, the craft of Cartography attained such Perfection that the Map of a Single province covered the space of an entire City, and the Map of the Empire itself an entire Province. In the course of Time, these Extensive maps were found somehow wanting, and so the College of Cartographers evolved a Map of the Empire that was of the same Scale as the Empire and that coincided with it point for point. Less attentive to the Study of Cartography, succeeding Generations came to judge a map of such Magnitude cumbersome, and, not without Irreverence, they abandoned it to the Rigours of sun and Rain. In the western Deserts, tattered Fragments of the Map are still to be found, Sheltering an occasional Beast or beggar; in the whole Nation, no other relic is left of the Discipline of Geography.
– Jorge Luis Borges, On Exactitude in Science, (1975)
Related links:
March of the quants – FT Alphaville
Massively multiplayer online role-playing game – Wikipedia