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39
votes
7answers
3k views

Paradoxes in quantitative finance

Everyone seems to agree that the option prices predicted by the Black-Merton-Scholes model are inconsistent with what is observed in reality. Still, many people rely on the model by using "the wrong ...
23
votes
5answers
3k views

Why aren't econometric models used more in Quant Finance?

There is a big body of literature on econometric models like ARIMA, ARIMAX or VAR. Yet to the best of my knowledge practically nobody is making use of that in Quantitative Finance. Yes, there is a ...
18
votes
2answers
3k views

How do we use option price models (like Black-Scholes Model) to make money in practice?

In quantitative finance, we know we have a lot of option price models such as geometric Brownian motion model (Black-Scholes models), stochastic volatility model (Heston), jump diffusion models and so ...
18
votes
5answers
921 views

Model Validation Criteria

Let's say I have a brand new fancy model on some asset class (calibration porcedure included over a set of vanilla options) in which I truly believe I made a step forward comparing to existing ...
16
votes
6answers
2k views

George Soros models

Mr. Soros in his books talked about principles which are not used by today's financial mathematics — namely reflexivity of all actions on the market. Simply it can be given by following: ...
16
votes
2answers
1k views

Why isn't the Nelson-Siegel model arbitrage-free?

Assume $X_t$ is a multivariate Ornstein-Uhlenbeck process, i.e. $$dX_t=\sigma dB_t-AX_tdt$$ and the spot interest rate evolves by the following equation: $$r_t=a+b\cdot X_t.$$ After solving for $X_t$ ...
15
votes
2answers
557 views

Which interest rate model for which product

Given the multitude of existing interest rate models (ranging from simple to very complex) it would be interesting to know when the additional complexity actually makes sense. The models I have in ...
14
votes
4answers
3k views

Is there a standard model for market impact?

Is there a standard model for market impact? I am interested in the case of high-volume equities sold in the US, during market hours, but would be interested in any pointers.
14
votes
3answers
704 views

Discrete-time model: stock dynamics

I am working in the area of probability theory and for a case study I would like to make some calculations in finance. Since I am developing theory for the discrete time, I am interested in models for ...
12
votes
3answers
840 views

Operating parameters of market makers?

I'd like to get a feel for the operating parameters of official market makers. I'm looking more for discerning characteristics, rather than exact numbers or an exhaustive list of each MM. Examples: ...
10
votes
1answer
551 views

What methods do I need to learn in order forecast asset price movements?

What are the standard models used to forecast asset price movements? For example, if I were to trade an option, what model would I use in conjunction with option pricing models to forecast the stock ...
10
votes
1answer
258 views

How should FX options be priced when a currency is artificially capped?

The question is inspired by yesterday's (06/09/11) historic announcement by the Swiss National Bank that it would impose a ceiling on the franc of 1.20 against the euro. I would like to know if there ...
9
votes
3answers
204 views

Validating a Credit Scoring Model without Data

Fellow Quants, Suppose you have a credit scoring model that is developed without the aid of statistics, because (unfortunately) there is no historical default/loss data in your portfolio. The ...
9
votes
3answers
1k views

Implementing a Fast Fourier Transform for Option Pricing

So, I'm in need of some tips regarding a small project I'm doing. My goal is an implementation of a Fast Fourier Transform algorithm (FFT) which can be applied to the pricing of options. First ...
9
votes
1answer
738 views

Monte carlo portfolio risk simulation

My objective is to show the distribution of a portfolio's expected utilities via random sampling. The utility function has two random components. The first component is an expected return vector ...
9
votes
3answers
1k views

Does the gamma function have any application in quantitative finance?

I was looking into the factorial function in an R package called gregmisc and came across the implementation of the gamma function, instead of a recursive or iterative process as I was expecting. The ...
9
votes
1answer
423 views

Are there any standard MBS coupon stack models?

I need to model MBS coupon stack prices. It would not be difficult to create something from scratch, but I don't want to re-invent the wheel (and explain why I did) if a somewhat standard model ...
7
votes
1answer
264 views

What are some quantitative ways to obtain the view confidences in Idzorek's version of Black-Litterman?

I'm using Idzorek's version of the Black-Litterman model for estimating asset returns. Idzorek's version bypasses the need to estimate directly the covariance matrix $\Omega$ of errors in the various ...
6
votes
1answer
788 views

Multi Fractals Models

From a quant point of view, how would you explain Multi Fractals Models in few words ? I have the level to take these courses, but won't be able to do it next year, so I want to know what I am missing....
6
votes
2answers
220 views

Question about equations and risk factors.

Say I have two risk factors $X_1$ and $X_2$. Standard deviation for $X_1$ is $\sigma_1$ and $\sigma_2$ for $X_2$. Furthermore, $X_1$ has a mean of $\mu_1$ and $X_2$ has a mean of $\mu_2$. Correlation ...
6
votes
1answer
190 views

How to scale option pricing components in regard to time

I am looking at closed-form options approximations, in particular the Bjerksund-Stensland model. I have run into a very basic question. How should I scale the input variables in regard to time? My ...
5
votes
2answers
194 views

How to derive this approximation of the risk-neutral expectation of the variance?

On the paper Bollerslev, Tauchen and Zhou (2009 RFS) the authors say about equation (15): The corresponding model implied risk-neutral conditional expectation $$E^Q_t(\sigma^2_{r,t+1})=E_t(\...
5
votes
1answer
131 views

What are the empirical limitations to testing market efficiency?

I have encountered a rather elegant argument about the limitations of empirically testing for market efficiency, involving the central point that we do not know whether a result is due to the "true ...
5
votes
1answer
606 views

Is Behavioral Finance relevant to quants?

This topic has been prompted by the following question: Measuring Behavioral Finance Effects in Fund/Portfolio Manager Analysis After reading it and the comments below I started thinking whether ...
5
votes
1answer
369 views

KMV-Merton Probabilties of Default vs Moody's EDF

Moody's used to publish probability of default estimates from their Moody's EDF model, but they have temporarily discontinued it. I understand that the Moody's EDF model is closely based on the Merton ...
5
votes
2answers
268 views

Intuition behind interest rate models

I am modelling the 3M yield of US Treasuries using an ARMA/ GARCH approach. Most interest rate models (e.g. Vasicek) describe the process as follows: $r_{t}-r_{t-1} = some ARMA+ \epsilon_t $ ...
5
votes
4answers
2k views

Typical coefficients uses in square-root model for market impact

The square-root model is widely used to model equity market impact. It assumes that volatility, traded volume, total volume, and a spread cost are the drivers of slippage. Jim Gatheral has an ...
5
votes
1answer
230 views

Can binary model lead to non-normal distribution?

If we suppose an instrument goes up or down 1 tick per $\Delta t$ (binary model), its long term distribution will be normal, per the Central Limit Theorem. However, suppose we model as follows: The ...
5
votes
0answers
72 views

Estimating Number of “Day Trades” from Total Volume of Commodity Futures Contract

Looking at futures data I am trying to calculate/estimate the number of "day trades", i.e. positions that were initiated and closed during the same day, as distinct from those positions that were ...
4
votes
1answer
395 views

How to find optimal look back in quant trading models

I'm in the process of building a quantitative trading model, I want to improve on the way in which I decide upon a look back length for the indicators. I understand the different pros/cons for very ...
4
votes
1answer
265 views

Evaluation volatility with Garch model

I want to forecast the volatility (with Garch) of a canadian stock in 5 months with daily returns. How many data do I have to collect ? Thanks.
4
votes
1answer
162 views

What are some common models for one-sided returns?

One typically models the log returns of a portfolio of equities by some unimodal, symmetric (or nearly symmetric) distribution with parameters like the mean and standard deviation estimated by ...
4
votes
1answer
266 views

ARIMA model, cannot get rid of low order ACF spike

I've gone through all the steps to fit a good ARIMA model - I plotted the data, I looked at the ADF tests, I looked at the ACF plot with no AR and MA terms just a constants. I came up with an ARMA(0,1,...
4
votes
2answers
387 views

law of one price, understanding

I am reading about mathematical finance, and I was tipsed to ask the quesiton on this site. It is about the "law of one price". Just first I'll make precise the model my book uses: I have a single ...
4
votes
0answers
191 views

Discrete-time Jump-Diffusion Model

I am wondering if anybody could point me to any literature that talks about a discrete time version of the jump-diffusion model, I am aware that there is a paper by Amin (1993) that shows a discrete ...
4
votes
0answers
767 views

Help With Quant Modelling Software [closed]

Im a software developer (freelance) working in investment banking, and I'm looking to improve my CV by gaining a better understanding of the financial quant role and the software used by quants to ...
3
votes
3answers
125 views

Parameters variation in fundraising financial model

I have created quite a large financial model in Excel with lots of input parameters which (after all calculations) have an influence on the output business indicators. Among the input parameters are ...
3
votes
1answer
497 views

mortgage prepayment model

I am trying to develop my own MBS prepayment model. I am confused by the terms SMM and CPR. Are they estimates/models in themselves or are they ACTUAL data for the MBS pool. where can I find actual ...
3
votes
1answer
144 views

Binomial lattice convergence

How do I measure how quickly a binomial lattice converges to an option value as the number of steps is increased? I'm charting option value versus number of steps for various binomial lattice models ...
3
votes
0answers
226 views

How are quants able to verify whether their calculated prices are any good

This question is related to the discussion on Model Validation Criteria However it appeard to be very high level to me and I would like to go more into detail. Not working at a pricing desk the ...
2
votes
3answers
475 views

Why do long-term equity return forecast models use dependent observations?

I've been reading up on different models used to forecast the equity risk premium, and I've seen a couple of papers that had questionable methods. For example, this paper by Javier Estrada goes into ...
2
votes
4answers
190 views

Are there any derivatives which pay amount $a(p-b)^{2}-c$ where $p$ is the price of underling asset?

Are there any derivatives which pay amount $a(p-b)^{2}-c$ where $p$ is the price of underling asset ? (or in the case of options $max(0,a(p-b)^{2}-c)$) I'm not very strict here but I only want to know ...
2
votes
1answer
35 views

Help understanding factor modeling, solving for residuals

I am trying to understand and implement a factor model, and I think I might be having some issues. I am trying to solve for the residuals in the equation: $$ R_{i} = \sum_{A=1}^{K}\beta_{iA} f_{A} + ...
2
votes
2answers
443 views

Ideas about Stochastic volatility models

I am currently working on comparing different models for modelling the volatility and then pricing vanilla options (I use option prices on real stocks in order to calibrate my models and then I ...
2
votes
1answer
153 views

Negative Eonia rates

I'm curious how the current negative Eonia (Euro OverNight Index Average) rates would impact derivatives pricing. Does it mean that if I post cash collateral to you, I also need to pay you interest? ...
2
votes
1answer
54 views

Loss given default for Agency MBS

The question is regarding the LGD of Agency MBS. Although Agencies never defaulted, the Basel framework requires to calculate the Agency MBS LGD for capital requirement. The closest benchmark I can ...
2
votes
0answers
32 views

Specifying integration level of time series [closed]

Following model was estimated on 200 observations. How to specify the level of integration of $X_t?$ In brackets there are standard errors and p-value of Breusch-Godfrey test is also shown. $X_t=0,02+...
2
votes
0answers
59 views

What is the main reasons to use Miltersen & Schartz (1998) model for commodity futures options

versus a standard Generalised Black and Scholes model (if there are any?) I have read the paper but I am not to sure about its practical implications as would people with more experience using this ...
2
votes
0answers
62 views

Calculating the error of a Trinomial Model

I've been trying to find a formula to obtain the maximum relative error a trinomial model with n timesteps will incur given all other inputs as compared to the standard BSM model. I'm concerned mostly ...
1
vote
1answer
57 views

Is it possible that some types of financial systems can resonate?

Financial systems can certainly be modeled using the same tools physicists use to model dynamic physical systems. The validity of such is evidenced by models such as that developed by Black and ...