Questions tagged [theory]

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Does the usual theory (e.g. Black-Scholes) make sense for FX options?

When you open any book about option pricing theory, you have this kind of setting: A risky asset whose value at time $t$ is $S_t$. A risk-free asset whose value at time $t$ is $S^0_t$. A portfolio ...
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Deviation between spot price and implied spot price of S&P500 mini-futures

From Derivatives Markets (McDonald) it is stated that we may price a financial forward and, equivalently, get an implied spot price from a given futures price: $$ F_{0, T}=S_0e^{(r-\delta)T} \implies ...
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What limits the maximum possible returns when shorting crypto?

I'm new to finance and crypto and this question is more of a thought experiment so I would like to hear both theoretical as well as practical considerations. Suppose I would like to short a particular ...
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Lower volatility corresponds to higher market efficiency?

What are the general ideas about volatility? It is generally said that volatility signifies risk, which reduces liquidity and thus efficiency. Is it actually so? Can't volatility be associated also to ...
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Why does the definition of the riskless asset vary in discrete vs continuous time?

In a multi-period market model, let's say we have $d+1$ assets $(S^0,S)=(S^0,S^1,\dots,S^d) $, where $S^0$ is the riskless asset, invested in a money market account. In continuous-time finance I ...
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What is the "recursive moral hazard theory" of "trade credit"?

When reading a recently published paper, I saw the paragraph We construct a sample of over 200,000 supply chains to conduct a chain-based analysis of trade credit. Our study uncovers novel stylized ...
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Theoretical returns of Short Straddle in an efficient Options Market

Assumptions: Market is efficient All assumptions of BS Model apply Implied Volatility predicted using BS model is same as actual volatility in future. Needless to say that the volatility is constant ...
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Rebalancing market-cap-weighted investments

I've just (hypothetically) invested $1m in two market-cap-weighted global equities tracker funds: one large+mid-cap tracker and one small-cap tracker. Both are of an accumulation share class, and I ...
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Hypothetic derivative that absorbs underlying volatility

Market participants are usually assumed to be risk-averse and striving to improve the Sharpe ratios of their portfolios. Thus, if we have an asset A, which is expected to return between \$900 and \$...
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2 answers
190 views

Starting Point for understanding Financial Theory for a Statistician

I am a Master’s student in Statistics who is interested in the field of Financial Modelling. I have very little experience or knowledge of Finance and have mostly worked on introductory projects in ...
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3 votes
1 answer
792 views

Anyone has detailed explanation on how to use epstein-zin preferences in asset pricing models

I'd be interested to know how Epstein-Zin preferences are used in, say, consumption-based asset pricing models. I'm looking for specific derivations (how you get the SDF) and possible numerical ...
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Is it possible to build a computer model to simulate a market to prove whether efficient theory is true or not?

I know this may sound stupid. But I had this idea and wanted to try it out for a college project. Has this been done before? If and what's wrong with this idea?
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Why someone would prefer CFDs rather than stocks?

From Investopedia: Essentially, CFDs are used by investors to make price bets as to whether the price of the underlying asset or security will rise or fall. That's the same with stocks, right? ...
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2 answers
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theoretical reason for which we can use monte carlo simulation for option pricing

The classic way to price an option is solving either analitically or numerically the associated PDE subject to the terminal and boundary conditions. An alternative approach is to use monte carlo ...
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currency pegging & FX reserves of central banks

Any good references on the math behind currency pegging by central banks as a function of: - the bank's balance sheet - market prices of the 'master' currency...specifically, how the bank traders (...
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"Correct" way to average OAS of multiple securities?

Suppose one wants to compute an OAS on a portfolio of securities, but one can only compute the OAS of the individual securities. Is there a "best" way (under some metric) for one to go about doing ...
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question on XIRR (excel)

Let's say we have an initial investment of -10 on 1/1/2000, and from 1/1/2001 to 1/1/2018 (with annual payments on Jan-1 of each year for 18 years) we get a CF of +2 each year with a final payment of ...
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What are the reasons that make stock return - bond yield correlation a meaningful one?

I have come across interesting charts that show the changing correlation between stock returns and government bond yields. My gut instinct tells me that such relationship would be expected to be ...
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2 answers
101 views

Firm specific risk

I know that according to traditional finance, firm-specific risk plays no role in the pricing of an asset but only systematic risk. On the other hand, the stock price should reflect all discounted ...
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2 votes
1 answer
378 views

Collateral replication argument

I'm trying to follow the replication argument in the first page of the following paper http://www.math.columbia.edu/~fts/Collateralized%20trade%20pricing%20made%20simple%20v1a.pdf One can however ...
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1 answer
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How can I measure wealth gain (loss) due to inequality?

As time passes, outside of inflation, the buying power of an individual changes relative to their peers wealth. How can I measure the effect wealth inequality has relative to one's savings?
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1 answer
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Explain Four Basic Axioms of Maximising Expected Utility

I begin learn PRM , Someone help me understand Four Basic Axioms of Maximising Expected Utility most intuitive way .Thank you very much
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5 votes
0 answers
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Show that in an arbitrage-free and non-redundant market a certain set is compact

Some notation: We consider a financial market with $d+1$ assets, the $0$-th asset is considered the risk-free asset, the others are the risky ones. The vector $\overline \pi \in \mathbb R^{d+1}$ ...
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14 votes
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Here is an approach for measuring Data Snooping; is it new?

I came up with an approach for measuring data snooping, or overfitting. My question is whether this approach was published and expanded-on already, or is it new? My approach relies on the observation ...
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1 vote
1 answer
222 views

Can a null be inconclusive? [closed]

My Null for the T-test is h0: -tcritical < Tstat < +tcritical I require confidence level of 95%. If my empirical result satisfies the null, but not my p-value requirements, does this mean ...
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What are the roles of "Game theory" and "optimisation (linear, integer, conic)" in Finance, Mathematical Finance? [closed]

Would you please give me some information about application of "Game theory" and "Optimisation" in Finance and Mathematical Finance? which is more important to know and learn? How about "multi-...
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6 votes
3 answers
2k views

What should I put on a math finance cheat sheet?

What are the most useful results that I should put on a mathematical finance cheat sheet? Am I missing anything important: https://github.com/daleroberts/math-finance-cheat-sheet
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2 votes
1 answer
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Is the volatility of a trader's wealth equal to the volatility of the underlying assets traded?

Assume that a trader trades in several stocks with different volatilities. The return of the trader's portfolio would be the weighted average of returns and the risk would be a function of the the ...
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6 votes
1 answer
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Definition of orthogonality and independence for a stochastic processes

Somehow I can't find the explicit definition of when two processes are supposed to be orthogonal or independent anywhere. I think orthogonality and independence should mean the same thing in this ...
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3 votes
0 answers
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Characterizing relation " has no less information than" between information systems represented by Markovian matrices

I crossposted this question on math.stackexchange. Background: Suppose that an investor's utility is both determined by the state and her action taken. A fact of life is that she can't observe the ...
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3 votes
1 answer
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What's the underlying idea of definition of constrained market in Skiadas' Asset Pricing Theory?

I'm self-studying Skiadas' Asset Pricing Theory, and find the definition of constrained market on page 21 confusing(you can find it here in the sample chapter). Definition 1.26. A constrained market ...
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11 votes
2 answers
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Is it possible to understand financial theory without mathematics?

I am trying to develop a short course on financial theory, covering the fundamentals of forward and options pricing, and 'efficient market' theory. I want to reduce the amount of mathematics to a ...
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8 votes
1 answer
552 views

Toy models of asset returns

When making simple agent-based models of banking systems to look at global properties (say systemic risk) one of the basic decisions you have to make is how to model returns on external (to the ...
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8 votes
4 answers
1k views

Why should there be an equity risk premium?

After years of mathematical finance I am still not satisfied with the idea of a risk premium in the case of stocks. I agree that (often) there is a premium for long dated bonds, illiquid bonds or ...
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17 votes
9 answers
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Has spectrum analysis ever been used successfully to analyse historical price data?

Spectrum analysis is often used to analyse waveforms. A common configuration, for example, is to create a graph where X is time, Y is frequency, and the brightness of each position represents ...
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2 votes
1 answer
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What are some "Must Know" investment/portfolio management theories out there?

What are the most important portfolio management theories you must know in order to competently manage an investment portfolio? In order to keep the topic focused, I would like to narrow down the set ...
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27 votes
6 answers
12k views

Why is an inverted yield curve a problem?

Immediately preceding the worst of the financial crisis, my professors all pointed out to me that the yield curve had inverted -- short-term yields were more risky than 20-year or 30-year Treasury ...
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9 votes
2 answers
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Why doesn't Black-Scholes work in discrete time?

I have a question considering Financial markets in discrete Time. One of the main theorems in discrete time is the following. In finite discrete Time with trading times t={1,...,T} the following are ...
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17 votes
3 answers
963 views

Empirical or theoretical quant insights that have shaped your thinking?

What are some quant theoretical or empirical insights that have shaped your thinking or provided a deeper conceptual basis for explaining returns and risk?
25 votes
5 answers
8k views

Why hold options when you can dynamically replicate their payoff?

When holding vanilla options, you can cancel out, theoretically, all risk with dynamic (delta) hedging. Then you earn the "risk free rate of return". Why would you make such a portfolio when you can ...
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4 votes
1 answer
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How to quantify the impact of management cost on return?

Suppose funds X and Y are the same but X has 0.25% higher management cost. Suppose we are analyzing a 2 year interval. The simple models with discrete/continuous interval -assumptions are not really ...
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14 votes
1 answer
3k views

How do I reproduce the cross-sectional regression in "Intraday Patterns in the Cross-section of Stock Returns"?

Recently I was trying to reproduce the results of "Intraday Patterns in the Cross-section of Stock Returns" (published in the Journal of Finance 2010). The authors used cross-sectional regression to ...
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110 votes
17 answers
15k views

What concepts are the most dangerous ones in quantitative finance work?

There are a few things that form the common canon of education in (quantitative) finance, yet everybody knows they are not exactly true, useful, well-behaved, or empirically supported. So here is the ...
26 votes
4 answers
4k views

Is there any theoretical basis for pattern-recognition strategies?

Mean-reversion and trend-following strategies have some kind of a theory behind them that explains why they might work, if implemented well. Pattern-recognition, on the other hand, seems like nothing ...
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