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Can Financial Engineering Cure Cancer? A Talk by Dr. Andrew W. Lo

December 20, 2018
Funding for early-stage biomedical innovation has been declining at the same time that medical breakthroughs seem to be occurring at ever increasing rates. One explanation for this counterintuitive trend is that increasing scientific knowledge can actually lead to greater economic risk for investors in the life sciences. While the impact of the Human Genome project, high-throughput screening, and genetic biomarkers has been tremendously positive for clinicians and their patients, it has also increased the cost and complexity of the drug development process, causing investors to shift their assets to more attractive investment opportunities. In this talk, Prof. Lo describes how financial engineering—portfolio theory, securitization, credit default swaps, and other tools of modern finance—can be used to reduce the risk and increase the attractiveness of biomedical innovation so as to bring new therapies to patients faster.

As explained by Dr. Lo, he became invested in the complexities of cancer and biomedicine after some friends and family became affected by the disease. From there, much of his knowledge on the industry has come from studying literature regarding cancer drugs and drug development, upon which he realized that he could apply key theories from his background in financial engineering into the advancement of drug development.

The “-omics” Revolution

His MIT colleagues Phillip Sharp, Tyler Jacks, Susan Hockfield published a press release only two years ago describing the transformative convergence of science, technology, and engineering. Such convergence is accelerating the innovation of new therapies to treat diseases like cancer. Dr. Lo refers to this convergence as “The ‘-omics’ Revolution.” Different fields of science—from genomics to epigenomics and other similar sectors—have seen tremendous advances since the last decade.

Dr. Lo juxtaposes this with the decreasing ability to finance this progress. At the same time as these scientific breakthroughs are advancing the current state of the field, something peculiar is happening in response: disinvestment.

The Trifecta of Bad Investment

This disinvestment immediately struck Dr. Lo as completely counterintuitive to many of the principles of finance he was accustomed to. Shouldn’t these breakthroughs in the field make drug development an even more attractive investment?

In his lecture, Dr. Lo outlined the basics of drug development to explain this surprising discrepancy. Beginning in the laboratory where scientists are testing out different compounds and treatment therapies for a given disease, each phase of development takes at least two to four years, accumulating to 10-15 years in total combined duration of production, testing, and approval. This lengthy process comes with a proportionately massive price tag. According to Dr. Lo, the costs of developing a single anti-cancer compound accumulate to 200 million dollars.

The payoff can be great. Upon approval, a single anti-cancer drug generates up to two billion dollars a year for almost a decade. That is, if the drug gains approval and sees success. At a success rate of under 5%, cancer drugs make for an incredibly risky investment.

The risks are amplified by the fact that the health field has found that the combination of different, already-existing drugs may be more effective treatment than one drug alone. The problem lies in the fact that there are currently about 2,800 approved drugs in the market. Following the math, there are about three million unique combinations when only looking at combinations in pairs of drugs, each requiring separate trials and massive costs. Moreover, if you’re a big pharma company with a successful drug, now there are 2,800 “choose-two” ways that your competitors can come up with a better therapy than what you have and make your drug worthless overnight.

The process of drug development is therefore characterized by what Dr. Lo calls “the trifecta of bad investment,” as defined by its extensive and lengthy process, massive financial exhaustion, and low probability of success.

The Role of Financial Engineering

Investors are driven by risk and reward. Namely, they are drawn to low risk and high yield. To this, Dr. Lo finds that different applications of financial engineering help manage this risk in order to increase the appeal of drug R&D to investors.

In one example of the use of financial engineering, Dr. Lo framed a hypothetical situation in which, instead of investing into the development of a single drug combination therapy, investors are instead offered a package of different combination drug therapies. With each combination statistically independent of each other, the chances of making a successful drug become substantially higher. This is a prime example of the medical field taking from financial techniques. In this case, Dr. Lo proposes a portfolio of drug development packages.

The question now becomes: if it was too expensive to pay for the development of one drug, how do we raise the capital to finance an entire portfolio of pharmaceutical drugs? Further borrowing from key financial techniques, Dr. Lo proposes the issuing of bonds to gain the leverage to invest in such drug development.

The examples Dr. Lo uses are but a start to the potential impact that finance can contribute to the acceleration of drug discovery. From credit default swaps to collateralized debt obligations and other securities well recognized in the financial industry, Dr. Lo emphasizes the need for the biomedical field to focus not only on the scientific, but the financial as well.

It turns out that you need to have collaboration across various different stakeholders. The problems that drug developers are dealing with—they’re not biomedical problems, they’re not finance problems, they’re not accounting problems. They’re problems that cut across all of these different fields.

Dr. Lo makes an innovative case for the accelerated advancement of drug development, one that he acknowledges will require collaboration across different fields. Such collaboration faces some obstacles but it ultimately fosters the opportunity to make strides towards significant biomedical advances. Similar to how the convergence of science and technical engineering has paved the way for the advancement of drug discovery, the convergence of science and finance now has the potential to further stimulate breakthroughs in health and medicine.

About the Speaker

Andrew W. Lo is the Charles E. and Susan T. Harris Professor at the MIT Sloan School of Management, director of the MIT Laboratory for Financial Engineering, a principal investigator at the MIT Computer Science and Artificial Intelligence Laboratory, and an affiliated faculty member of the MIT Department of Electrical Engineering and Computer Science. He is also an external faculty member of the Santa Fe Institute and a research associate of the National Bureau of Economic Research.

His most recent book is Adaptive Markets: Financial Evolution at the Speed of Thought. He is currently co-editor of the Annual Review of Financial Economics and advisor to the Journal of Investment Management and the Journal of Portfolio Management.

His awards include Batterymarch, Guggenheim, and Sloan Fellowships; the Paul A. Samuelson Award; the Eugene Fama Prize; the IAFE-SunGard Financial Engineer of the Year; the Global Association of Risk Professionals Risk Manager of the Year; the Harry M. Markowitz Award; the Managed Futures Pinnacle Achievement Award; one of TIME’s “100 most influential people in the world”; and awards for teaching excellence from both Wharton and MIT. His book Adaptive Markets has also received a number of awards. He is a Fellow of Academia Sinica; the American Academy of Arts and Sciences; the Econometric Society; and the Society of Financial Econometrics.

Professor Lo received a B.A. in economics from Yale University in 1980 and an A.M. and Ph.D. in economics from Harvard University in 1984. From 1984 to 1988, he was an Assistant and Associate Professor of Finance at the University of Pennsylvania’s Wharton School. He has been at MIT since 1988.

PENN WHARTON PPI
RESOURCE SPOTLIGHT:

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