Friday, 2 September 2011

Another specialist risk assessment company gets bought out

Algorithmics, a company specialising in risk software for financial institutions, has been sold to IBM for $387m.

Agena partnered Algorithmics during the period 2003-2005 when there was a clamour for so-called 'advanced measurement approaches' to operational risk assessment. The Basel 2 accord specified that banks which used a validated advanced measurement approach to calculate their operational risk exposure could set aside a lower percentage capital allocation. This meant there was a major financial incentive for banks to develop such approaches. Most banks looked at Bayesian networks as a potential solution and, indeed, a number wanted Algorithmics to provide such a solution to integrate with the existing credit and market risk software that Algo provided. Algorithmics had started work on their own Bayesian network platform for OpRisk, but decided that AgenaRisk was superior. Hence we partnered them in projects with some major banks, with Agena providing the underlying Bayesian network technology and modelling skills and Algorithmics providing the reporting infrastructure.  Here is a paper we wrote that gives a feel for the BN approach to operational risk that we developed.

In late 2005 Algorithimcs actually got taken over by the Fitch Group. Since Fitch already had their own (non-Bayesian) OpRisk solution - which they had massively invested in - the partnership effectively ended then, as it appears did Algorithmics' interest in Bayesian networks. This is a great shame, especially when you consider the mess that financial institutions have made using classical statistics.

It is difficult to determine the extent to which banks are using Bayesian networks but, as we described here, there are plenty of financial analysts who are using fundamentally flawed methods in situations when the Bayesian approach would work.