31
votes
Accepted
Why aren't econometric models used more in Quant Finance?
It's an interesting question.
I particularly agree with the $\mathbb{Q}-\mathbb{P}$ dichotomy mentioned by many.
I would add to the other answers that, come to think of it, the Black-Scholes ...
- 14.5k
17
votes
Why aren't econometric models used more in Quant Finance?
I think you need to differentiate between Q-quants vs P-quants. The former might not use Econometrics, but P-quants use them a lot.
- 4,307
12
votes
Why aren't econometric models used more in Quant Finance?
Traditional econometric (time series) models are of little or no value in forecasting market prices for purposes of "making money", i.e, generating excess return over a benchmark in an asset ...
- 3,595
8
votes
Why aren't econometric models used more in Quant Finance?
My answer is very much in the spirit of Kiwiakos' answer.
E.g. in this paper (where I am one of the coauthors) we use VMA (vector moving average) models (in the multivariate case) and AR models in ...
- 13.6k
8
votes
Why aren't econometric models used more in Quant Finance?
Having thought about this I think the following reason is also important and wasn't mentioned so far:
When you look at the inner working of this whole class of econometric models it all boils down to ...
- 27.3k
7
votes
Accepted
Reconciling Two Claims About Volatility Under Fat Tails
I don't think the claim that "Lévy alpha-stable distributions are better descriptors of returns" is universally accepted.
While Mandelbrot (and others before him) has correctly identified ...
- 203
6
votes
Accepted
Modelling and forecasting mixed frequency financial data
MIDAS is useful when you have a low frequency series and you want to include high frequency data in the regression. So for instance, if you want to forecast quarterly GDP data and want to include ...
- 5,391
6
votes
Accepted
Model to Predict the Change in IV of an Option
One approach that I have seen being used is to try to model the (joint) dynamics of the forward at-the-money volatility as well as its first one or two derivatives. The idea is to find a ...
- 5,959
5
votes
Accepted
Portfolio of sum of two Bachelier processes
Since $dW_A$ and $dW_B$ are already correlated as per the way you construct it, your portfolio being the sum of the two is already correlated.
If you want it very explicitity written out, then you ...
- 1,558
5
votes
Accepted
Model reference price of Limit order book
This reference price is also sometimes called intrinsic price. One of the simplest ways to improve it in regards to the mid-price (assuming you have the depth data) is the following:
define a ...
- 1,012
5
votes
Accepted
GARCH volatility modeling, squared returns, and convergence
Assume that your stationary time series (here a daily close-to-close log-returns' series) is modelled as follows $\forall t \in \mathcal{T}=\{1,...,N\}$
\begin{align}
r_t &= E_{t-1}[r_t] + \...
- 14.5k
5
votes
Accepted
how are financial data with sparse and asynchronous features imputed in predictive modeling?
There is large literature on MIDAS (mixed-frequency data sampling) models, the leading scholars being Eric Ghysels and Rossen Valkanov — google their research for references. However, the ...
- 932
5
votes
Accepted
Why do we not use copula for forward starting options?
One is exploring forward volatility of a price of a single asset (joint distributions from within a process), the other explores correlation of two prices at the same time for two different ...
- 5,008
4
votes
Why do we usually use normal distribution and not Laplace distribution to generate stochastic process?
If you're willing to drop the requirement to have continuous paths, or rather, if you're willing to relax it, it is possible to have a bigger class of stochastic processes called Lévy processes. The ...
- 1,507
4
votes
Why do we usually use normal distribution and not Laplace distribution to generate stochastic process?
It is very natural to think that why assumption of Normal distribution is made for stochastic process $W_t$ when other more appropriate and valid distribution is available specially for modelling ...
- 2,218
4
votes
What are the main differences between discrete and continuous time models when modeling asset price dynamics?
Continuous time has a so-called elegance, but it is rarely correct. Most Q-measure people rarely care about correctness anyway, since they usually don't root their models in statistics. With no ...
- 1,068
4
votes
Is there a way to meaningfully generate daily returns from monthly?
This is a commonly seen problem, and also relates to situations in which one is dealing with some less-liquid underlyings. I will describe a method that you could think of as "stochastic backfilling" ...
- 429
4
votes
Model to Predict the Change in IV of an Option
I would say that Derman's 99 paper on "Regimes of Volatility" (also called volatility "stickiness assumptions" by some practitioners) is an excellent place to start your investigations.
Here is the ...
- 14.5k
4
votes
Accepted
why calibrate volatility and fix the mean reversion
Fixing the mean reversion, and parameterizing the volatility as a step function or as a piecewise linear function, the volatility can be bootstrapped exactly to a set of vanilla options sorted by ...
- 5,622
4
votes
Pros and cons of mean equation equal to zero in a GARCH model
When you model log-returns $(Y_t)$ by $Y_t=\varepsilon_t$ where $\varepsilon_t|\mathcal{F}_{t-1}\sim N(0,\sigma^2_t)$ and a standard GARCH($p,q$) model with $$\sigma_t^2=\omega+\sum_{i=1}^p \alpha_{i}\...
- 15.2k
4
votes
Accepted
Do different prices under different models admit arbitrage?
This phenomenon is not limited to interest rate derivatives. Any time a product is priced to model - be it equity derivatives, commodity derivatives, simple cash products whose price is not observable ...
- 11.9k
4
votes
Accepted
Understanding out-of-sample performance metrics for Realized Volatility
You can compare the losses against each model and determine the "best" model to be the one with the smallest losses. In many cases for larger studies, the results might be ambiguous where ...
- 4,176
3
votes
Accepted
How is fundamental data taken into account when modelling stock prices with a Geometric Brownian Motion?
It turns out that GBM with constant drift and constant volatility is not really used in real life. It is well known that volatility as well as drift may vary over time. Hence, if you want to use a ...
- 279
3
votes
Ideas about Stochastic volatility models
You can look at Bergomi's variance curve model (see his Smile Dynamics articles).
Another interesting article is Bergomi and Guyon's smile in stochastic volatility model where they give a very nice ...
- 3,936
3
votes
Is there a way to meaningfully generate daily returns from monthly?
Kalman filter (or similar methods) are quite well suited to deal with observations that are of different sampling frequencies and/or asynchronous.
- 4,307
3
votes
Mean and standard deviation of price series with Kalman
I would suggest check out the Wikipedia page first and use more stylized notations.
In your update equation mean(t) = mean(t-1) + K(t) * ( price(t) - mean(t-1) ) ...
- 702
3
votes
Model to Predict the Change in IV of an Option
You may be interested in these papers by Dumas et al. (1998) and Goncalves and Guidolin (2006). Here the abstracts:
-Dumas et al (1998):
Black and Scholes (1973) implied volatilities tend to be ...
- 1,886
3
votes
Accrual in Default Derivation of Credit CDS Curve
The accrual on default is like the accrued interest on a bond. A credit default swap can be looked as a synthetic bond. As such, with each passing day, interest is earned to the seller of protection ...
- 5,662
3
votes
Accepted
Accrual in Default Derivation of Credit CDS Curve
The formula for the accrual on default
$$
S_n \sum_{i=1}^n \frac{\Delta_i}{2}(Ps(i-1)-Ps(i))DF_i
$$
is just an approximation that says conditional on default occurring within period $i$ (probability ...
- 5,622
3
votes
Accepted
Lattice pricing of derivatives under multi curve framework (OIS and LIBOR)
There are many resources describing how to build a trinomial tree for the Hull & White model (for instance http://www-2.rotman.utoronto.ca/~hull/downloadablepublications/TreeBuilding.pdf), and ...
- 5,622
Only top scored, non community-wiki answers of a minimum length are eligible