Can Financial Engineering Cure Cancer?

Can Financial Engineering Cure Cancer?

Professor Andrew Lo from Massachusetts Institute of Technology (MIT) said he wants to participate in finding drugs for cancer. However, Professor Andrew Lo is a financial economist, not a doctor. So then, how can the professor contribute to research for drug development? While participating in drug development, he discovered that funding is a problem in drug development. As a result, pharmaceutical companies prefer to develop specific processes such as marketing, distributing, licensing, and sales rather than focus on research. Moreover, Professor Andrew Lo also mentions that establishing a new drug takes 10-15 years.

Furthermore, The high cost of cancer research with a small probability of success is why most pharmaceutical companies do not see this as a proper project. Like a company, many students are taught that there is a trade-off between risk and reward. Hence, we should get extra rewards because of bearing higher risk. But then, if it is the case, how can investors see that drug development project to cure cancer as an attractive and feasible project?

Professor Andrew Lo suggests applying Wall Street-style financial engineering can help fund cancer’s drug development project. He finds that combining drug development projects in a single portfolio reduces risk and, at the same time, increases the reward. For example, suppose a certain amount of money is invested in 150 drug development projects simultaneously, and each project has a 5 percent probability of success. In that case, there will be a 98 percent chance that three drugs will be successful. However, if a project costs around $200 million, the portfolio will require $30 billion.

He also comes up with issuing cancer bonds and other financial tools such as securitization and credit-default swaps. He mentioned that several investment funds had adopted this method into practice. In contrast, the same method related to securitization caused the financial crisis in 2008. The securitization of subprime mortgages caused havoc on financial systems in the United States, and The Federal Reserve tried to solve the problem with Quantitative Easing.

Furthermore, Professor Andrew Lo believes it is not the method that did not work correctly. Yet, the financial crisis happened because the method worked too well. Despite the result, this method can generate a massive amount of money in a short period. After all, he said that some issues have to be concerned about this method. Yet, rather than focus on the issues, it is better to concentrate on changing the assumptions and forecast to generate a proper expected return.

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