Investment Banking Essay Example | Topics and Well Written Essays - 3000 words

Investment Banking - Essay Example In UK the investment banking scenario has undergone radical transformation in the two decades covering the period 1985-2005.In the following paragraphs we probe available literature in order to outline main drivers of this transformation and emerging scenario. There have been very many drivers determining the landscape of investment banking activities in UK.Principal among them are new paradigms in regulation and supervision over investment banking activities and changed due to high risk assumption by agents as traders and investment banking failures, US influence through take over, merger and acquisitions of British investment banking activities, increasing importance of relationship banking and radically altered scale of FDI activity in UK area since late 1980s reflective of hastening pace of globalization and relationship relocations. The trading theory in finance exclusive reliance is placed on expected utility theory (Bernstein, 1996). Even agency theory of trading like expected utility theory, has, since Williamson (1963), assumed consistent risk aversion of agents acting for risk neutral principals. Principals, are assumed to be risk neutral as they can diversify their share holding across firms, are forced to either incur opportunity costs in monitoring agent activities or give agents bonuses/ incentives to equal agents' and their risk appetites. (Eisenhardt, 1989;Tosi and Gomez-Meija, 1989; Beatty and Zajac, 1994; Jensen and Meckling, 1976).Similarly both expected utility and Agency theories assume perfect rationality .However Agency theory has defined aggregate irrationality in the form of Noise trading. Dow and Gorton (1997) state that traders have problems taking rational decisions between 'simply doing nothing', 'actively doing nothing' and the need to avoid contracts which give incentives for inactivit y. In dilemma, agents may get in ex ante unprofitable trades that have some chance of being profitable ex post' (Dow and Gorton ,1997).Market turns more liquid and trades entered in far exceed principals' requirements. In case ex-post profit expectations come untrue-widespread trading losses are experienced. Sociological and psychological approaches have also explained irrational trading behavior and unnecessary risk assumption and realized trading losses leading to malfeasance charges. Among them important are irrationality causing factors such as trading on the basis of personal familiarity (Baker, 1986),herding (Adler and Adler, 1984), and decision making affected by stress (Kahn and Cooper, 1993), prospect theory defined as a preference for the avoidance of loss, even at higher risk (Kahneman & Tversky, 1979, Tversky and Kahneman, 1986), judgmental biases in decision making (Bazerman, 1998) , imputed rather than measured - decision making bias by individual traders(Thaler, 1991, 1993; Shefrin, 2000).This sets the theoretical foundation for high risk assumption and losses in trading activities by investment bankers agents. High bonus payments