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Fixed Income Technology

By Triet Nguyen, DPC Data

Beyond The Hype: Potential ChatGPT Use Cases For The Fixed-Income Markets

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“Plus ça change, plus c'est la même chose” “The more things change, the more they stay the same” Jean-Baptiste Alphonse Karr (1849)

As the Federal Reserve continues to tighten the screws on the economy, the only thing holding up the valuation of technology stocks since last December has been the advent of Artificial Intelligence (“AI”) and its new user-friendly application, Chat-GPT. In only the span of a few months, AI has made the leap from the deep recesses of technology labs to becoming a nightly topic on the evening news. In this article, we take a preliminary look at the potential use cases for Chat-GPT in the fixed -income markets, while trying to cut through the current market hype.

What Is Chat-GPT, Really?

While AI in various forms has been in development for decades, its latest breakout can be attributed to the public release of Chat-GPT, an application that can converse with the user in normal, every day language. Just a friendly chat with a “near-sentient” software, that’s all. Without getting too technical, “GPT” stands for “Generative Pre-Trained Transformer” and GPT-4 is the latest version of a powerful language model that can generate human-like text. Generative AI basically combines the capabilities of Natural Language Processing (“NPL”) and Machine Learning (“ML”). It can also analyze a large amount of data and extract insights from it. More recently, Generative AI can also create other types of content, such as images, videos and audio.

AI and The Bond Market

With all those capabilities, can AI and Chat-GPT benefit the bond market? Fittingly enough, we should let Chat-GPT state its own case. Here’s what it has to say about potential use cases for AI in the fixed-income markets (Note: passages in italics were compiled and edited from various responses by Chat-GPT to our rather pointed questions):

Market Intelligence and Forecasting

As an AI model that's continually learning, ChatGPT can digest and analyze vast amounts of market data and news. It can keep bond traders up-to-date with the latest trends, news events, and economic indicators that impact bond prices.

ChatGPT can pull in data from multiple sources, analyze it using preset algorithms, and generate succinct, easily understandable reports. The AI can even analyze patterns in historical data and apply that knowledge to predict future bond market trends. Thus, it makes market analysis faster, more accurate, and efficient, freeing up analysts to focus on strategic decision-making.

Beyond just reporting on the current state of the bond market, ChatGPT can assist with predictive analytics. By analyzing historical data and market patterns, it can generate forecasts about future bond yields and prices, providing traders with valuable insights for decision-making.

Bond Analytics

One of the most direct use cases for ChatGPT in the bond market is in the realm of bond analytics.

For example, traders and portfolio managers can ask questions about specific bonds, sectors, or market trends, and ChatGPT, equipped with the latest data and trends, can provide comprehensive responses. This could range from providing an assessment of the credit risk of a specific bond based on the latest financials of the issuer, to predicting the impact of a change in the interest rate environment on a bond portfolio.

Trade Execution and Liquidity Analysis

Bond trading, traditionally a relationship-based, over-the-counter business, has been slowly shifting to electronic trading platforms. Herein, the application of ChatGPT could streamline communication, order placement, and execution. By leveraging ChatGPT, traders can execute orders, analyze liquidity and price securities using natural language commands. This not only enhances operational efficiency but also minimizes the risk of human errors, contributing to better trade execution and improved profitability.

Trading Bots

Trading bots are automated systems that can buy and sell bonds based on pre-determined rules. These bots need to be capable of interpreting market data accurately and making split-second decisions. With its advanced language understanding and generation capabilities, ChatGPT can be used to develop more sophisticated trading bots.

A ChatGPT-powered trading bot can process and interpret market data in real-time, apply complex trading strategies, and execute trades swiftly. It can also provide real-time updates to the traders, making the entire trading process more efficient and less prone to human error.

Risk Assessment and Management

Effective risk management is a fundamental concern in bond markets. Given the scale and complexity of financial data, parsing through spreadsheets and databases for risk assessment can be both time-consuming and prone to error. Deploying ChatGPT in this space can prove transformative.

With its capability to process enormous datasets, ChatGPT can identify patterns, trends, and anomalies that could signal potential risks. It can assess a portfolio's exposure to market, credit, and liquidity risk, making it an invaluable tool for risk managers. Moreover, it can deliver detailed, plain language summaries of complex financial data, making risk management more accessible and efficient.

Client Communication and Reporting

ChatGPT can also revolutionize customer service in the bond market. Chatbots are increasingly being used by financial institutions to answer customer queries, streamline processes, and provide personalized service. ChatGPT, with its superior language processing capabilities, can enhance the quality of these services. It can handle complex queries about bond investment, explain financial jargon in layman’s terms, and provide personalized investment advice based on the customer’s risk appetite and investment goals.

ChatGPT can generate clear, jargon-free reports that provide clients with meaningful insights into their investments. It can also engage with clients through chat interfaces, answering queries, and offering explanations about the bond market and their specific portfolios. The capability to engage clients conversationally and informatively is a significant step towards enhancing customer service in the financial sector.

Regulatory Compliance and Documentation

Regulatory compliance is crucial in bond markets. Ensuring adherence to changing rules, policies, and reporting requirements is an intricate and resource-intensive process. With ChatGPT, companies can streamline compliance tasks. The AI can interpret and summarize regulatory texts, update policies, and generate compliance reports, reducing the administrative burden on compliance teams.

Potential Pitfalls

While ChatGPT certainly has a high opinion of its own capabilities, it also appears to recognize its own limitations (its programmers being keenly aware of the massive potential legal risk):

While the use of ChatGPT in the bond market has significant potential, there are also important limitations to be aware of.

Data Dependency: ChatGPT's knowledge is based on the information it was trained on, which only goes up until September 2021. Thus, for real-time bond market analysis, it needs to be integrated with a constantly updated data feed. Even then, it doesn't "understand" information in the way humans do—it identifies patterns in the data it was trained on and uses those to generate responses [Note from Author: there is now a version that has up-to-date access to the internet. The Microsoft and Google versions also offer “real-time” access.]

Absence of Intuition: Traders often rely on their market intuition and professional judgement to make decisions, a factor that ChatGPT lacks. While it can generate predictions based on data patterns, it might miss out on subtle cues or complex market dynamics that experienced human traders can pick up on.

Lack of Contextual Understanding: Despite its impressive language processing capabilities, ChatGPT doesn’t fully understand context in the way a human does. It can provide responses based on patterns in the data it was trained on, but may not always interpret nuanced or ambiguous queries correctly.

Regulatory and Ethical Concerns: Using AI in the financial sector, especially for advising clients or making investment decisions, raises regulatory and ethical questions. For example, who is responsible if ChatGPT's advice leads to a significant financial loss? Clear policies and regulations need to be in place to govern AI usage.

Data Privacy: In cases where ChatGPT interacts with sensitive client information, there are potential data privacy concerns. Ensuring the AI operates within a secure environment and adheres to strict data privacy guidelines is essential.

Reliance on AI: Over-reliance on AI for decision making can be a potential risk. While AI can aid in decision making, human supervision is still necessary to manage unexpected situations and make ultimate decisions.

Is It All Hype?

Like any other groundbreaking technology (think the dot.com craze at the beginning of this century), AI and its new user-friendly face, ChatGPT, will go through the inevitable boom/bust cycle before its long-term cost/benefits can be assessed accurately, allowing it to truly fulfill its promise.

Notably missing from many current promotions of AI’s potential benefits is a realistic discussion of the upfront costs of gathering the data needed to train the Natural Language models and the computational resources required to do so. Firms such as Google and Microsoft, along with hordes of new startups, are pouring billions of dollars into developing the training data. It’s still unclear if and how they’ll be able to ultimately pass those costs onto AI users.

A key component of the cost equation, of course, is the potential upfront expense of building an appropriately ring-fenced database for your company’s proprietary use. You certainly don’t want to spend time training Chat-GPT so the rest of the world can have access to it!

At least for now, the raw data AI relies upon for training is still being created by humans in a decidedly manual fashion, those toiling away as data “annotators” (for a fascinating look inside one of these annotator factories, check out the article from The Verge, “AI Is A Lot of Work”).

At the end of the day, as the quote at the top of this article reminds us, “the more things change, the more they stay the same”. The age-old problem of availability and quality of data will ultimately determine the success of any AI applications. Here in our market, the next time you hear anyone sing the praise of a new AI software, make sure you ask he or she (or “they”) what kind of data it’s built on.