How to address AI’s market risk
Running Point and its chief investment officer, Michael Ashley Schulman, CFA, were quoted by U.S. News & World Report in an article — by reporter John Divine, “How AI Could Spark the Next Financial Crisis” — regarding Securities and Exchange Commission Chair Gary Gensler’s recent comments about artifical intelligence’s (AI’s) potential to induce a crisis and how best to address AI’s potential systemic risk.
Artificial intelligence flash crash or contagion
Similar to other computer trading systems, AI-driven trading algorithms can be susceptible to errors or bugs, which, if not properly identified and controlled, can lead to erroneous trading decisions that theoretically could snowball into a flash crash or contagion. The interconnectedness of AI-driven systems can create systemic risks, where the failure or malfunction of one system can propagate across the financial ecosystem.
Crucially, generative AI’s training data has to be similar to or aligned with the system used for trading. For example, a trading system fall apart because some traders wrote one million with six zeros and others used a short hand notation of 1,000 or because the placement of the periods and commas in numbering systems are different in different countries; e.g., United States 1,000,000; Switzerland 1′000′000; Germany 1.000.000; China 100,0000. You don’t want a trading system to accidentally sell a million contracts when it was only supposed to sell 100 contracts.
To mitigate these risks, rigorous testing and validation procedures should be implemented to ensure the accuracy and reliability of AI models. Regular monitoring and oversight are crucial to detect and rectify any algorithmic errors promptly. Robust risk management frameworks and stress-testing procedures should be in place to assess the potential systemic impact of AI technologies. Collaboration and information sharing among regulators, financial institutions, and AI developers could help identify and address systemic risks in a proactive manner.
Quoted article excerpts are below:
Disastrous AI trading systems. “Similar to other computer trading systems, AI-driven trading algorithms can be susceptible to errors or bugs, which, if not properly identified and controlled, can lead to erroneous trading decisions that theoretically could snowball into a flash crash or contagion,” says Michael Ashley Schulman, partner and chief investment officer at Running Point Capital Advisors, a multifamily wealth management firm in El Segundo, California.
Of course, limiting the scope of oversight to the field of finance may miss the forest for the trees. “Robust risk management frameworks and stress-testing procedures should be in place to assess the potential systemic impact of AI technologies,” says Schulman, who worries about errors in popular AI models propagating.
Disclosure: The opinions expressed are those of Running Point Capital Advisors, LLC (Running Point) and are subject to change without notice. The opinions referenced are as of the date of publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Past performance is not indicative of future results. Forward-looking statements cannot be guaranteed. Running Point is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Running Point’s investment advisory services and fees can be found in its Form ADV Part 2, which is available upon request. RP-23-60