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University of Virginia UVA Arts & Sciences Default

Ahead of the Curve: Economics Professor Ana Fostel Employs Mathematical Models to Decipher Shocks Across Global Markets

Sep 23, 2016 |

For some of Ana Fostel’s academic colleagues, her dissertation research seemed out of step. The bubble had peaked, and the afterglow of the U.S. economy’s prosperous run through the 1990s was fading, but housing prices were still soaring in 2005. Twenty years of incredibly low volatility in the United States had economists focused on the boom times, not searching for potential triggers to bank runs or wild fluctuations in the stock market.

Ana Fostel, Associate Professor of Economics

So why was this promising Ph.D. student from Yale University wrestling with mathematical models exploring how a highly leveraged housing market could explain financial crises and the possible boom/bust cycle of the U.S. housing market?

“I remember attending the American Economic Association meetings that year in Philadelphia, and I was talking to this professor from a very prominent university who had interviewed me,” said Fostel, now an associate professor in the College and Graduate School of Arts & Sciences’ Department of Economics. “And he asked me, “Why are you talking about margin calls and leverage cycles and crisis? Don’t you see the world surrounding you?’”

Only three years after that American Economic Association meeting, Lehman Brothers, Washington Mutual and other huge institutions failed, and Bank of America, Morgan Stanley and other huge financial institutions across the United States and Europe teetered near collapse. Fostel is quick to point out that she and her mentor and academic colleague, Yale professor John Geanakoplos, did not foresee the worldwide financial crisis touched off by what first appeared to be limited to a U.S. mortgage problem triggered by risky loans, credit default swaps and other esoteric derivatives.

But growing up in Uruguay, Fostel had lived through the currency and default crises of her native country and neighboring South American countries. Economic crisis was not, as she says, “an exotic concept” for her. Trained as a mathematician, Fostel was intrigued as a graduate student by Geanakoplos’ work on financial models examining the role of housing and other durable goods serving as collateral backing financial promises. That led to collaborations examining the root causes of financial default and “contagion,” or the spread of shocks across global markets.

Focusing on the intersection of macroeconomics and finance, Fostel employs models that focus on the role of debt in asset pricing to understand investment, growth, default and contagion. Her work, which has been published in American Economic Review, Econometrica and other top academic journals, examines timely and relevant questions at the vanguard of financial innovations, such as new ways to collateralize, or pledge, assets as a reassurance against default risk. Within their collaborative work, Fostel and Geanakoplos devised a theory suggesting the existence of an amplification mechanism within the global economic system that explains how the ripples from something like a dramatic downturn in the U.S. housing market can, within a leverage cycle, lead to a worldwide crash.

“It would be completely dishonest for me to say that I foresaw the 2008 crisis three years earlier,” Fostel says. “But I was drawn to these beautiful models that John [Geanakoplos] was working on at a very preliminary stage. And I thought it was a combination of elegant, simple math that could have the potential to explain important things. At that stage, it was really an aesthetic thing, something that I thought could potentially explain a lot of things that we see in emerging market economies, but it turned out actually in 2008 that this model had a lot to say about the crisis.

“As a social scientist, understanding how these financial markets work is crucial. The consequences of the 2008 crisis were not limited to the financial markets. It permeated the whole economy.”

‘A positive force’

After earning her Ph.D. from Yale in 2005, Fostel went on to George Washington University, where she first served as an assistant professor before being promoted to associate professor of economics and international affairs in 2011. She has spent terms as a visiting scholar at the Federal Reserve at New York, the International Monetary Fund and other policy institutions, and Fostel also has served as a visiting scholar at New York University, Yale University and the University of Pompeu Fabra in Barcelona, Spain.

Fostel joined UVA’s faculty in 2015, and her transition led to welcome opportunities for new collaborations, with new colleagues across Grounds.

“On the first day of my visit to UVA, I saw how vibrant a place this is. I realized that I was joining the Economics department at an amazing moment. We are in a period of aggressively hiring new people and growing as a department. It’s incredibly exciting. They are so many talented, creative faculty members here who think outside the box. And the students, they are just a pleasure to teach, so incredibly talented, hard working and curious.

“There is just a gravitas to the place. You can feel it.”

In her short time at the University, Fostel has delivered presentations on her theoretical work to colleagues across Grounds at the Darden School of Business and has been asked to serve on a faculty hiring committee for Darden.

Prof. Frank Warnock, the area coordinator for Darden’s Global Economies and Markets area, says that Fostel has already proven a valuable addition to the University.

“Ana is such a positive force. Having her here will help the University to recruit other talented faculty and researchers engaged in international economics and macrofinance,” Warnock said. “The other thing about Ana is that while she’s a top theoretical economist, she addresses practical, real-world issues. It’s not theory for theory’s sake; it’s theory with the purpose of trying to better understand some of the pressing issues in economics and finance. If I were a student, she’s exactly the type of professor I’d want.”

UVA undergraduate Yuesen He was among the students who took Fostel’s seminar on Global Financial Markets last spring. The class was more technical than other economics courses He had taken at UVA, the third-year student said, but her passion for the subject engaged the students.

“As technical and analytical as it was, she also stressed to us that financial economics was much more than just math problems. She explained how economic intuition would help one go a long way,” He says. “She also taught us how to start questioning the efficient market hypothesis by giving us a flavor of her current research in leverage cycle and collateral value, which I became deeply interested in. She did an experiment with the class that tested her theory, but I also wondered if collateral value could be proven empirically with real world market data. This has become one of my research interests, and I would love to see where it leads with Prof. Fostel’s guidance.”

Diego A. Legal Cañisá, a graduate student in the Department of Economics, called Fostel one of the best professors he’s ever had.

“She's really committed to helping students understand the material, and she makes students feel confident in asking questions,” Legal says. “Her class was one of the main reasons why I decided to focus my research in macro-finance topics, in particular on the macroeconomic effect of credit frictions and its relationship with other areas. I hope to keep working with Prof. Fostel on my research and to have her as one of my advisors.”

While teaching undergraduate and graduate finance courses, Fostel also served as the co-organizer of a major international conference on finance and macro-economic theory.  The conference, which was supported by the National Bureau of Economic Research’s Mathematical Economics Conference and the National Science Foundation, was held in Charlottesville for the first time last year. Under Fostel’s leadership, the conference will return to Charlottesville in November of 2017.  As one of the premiere conferences in economic theory, the conference will draw top-tier economists from around the world while also showcasing the current research of economists in the Department of Economics, the Darden School and the McIntire School of Commerce.  

As she juggles conference plans and her courses, Fostel says she is eager to extend her research.

“I do this because the models help us understand how these opaque markets operate and how these incredibly sophisticated financial instruments are valued and traded. This is something I care about and try to translate to my students,” Fostel says. “Since 2008, there has been a vocal movement of critics saying that economists didn’t predict the crisis and that all these mathematical models come with unrealistic assumptions, and I do think that was a very healthy reaction.

“But there are a lot of things, good things that come out of disciplined, mathematical techniques, and that is not over. A little bit of what I took out of last year’s NBER conference was the many different kinds of mathematical models offering incredible insights on what we saw in the crisis and what we saw after the crisis. So we shouldn’t quit. The unemployment and recession that followed the 2008 crisis made it very clear that if you care about social issues, you need to understand finance.”