Modelling in financial markets

This presentation explores the main types of models used in financial markets, including instrument valuation, risk measurement / management, idea generation and portfolio construction. For each type it explores the purpose and main characteristics of such models and the principal areas of model risk

1Modelling in financial markets
2Modelling in financial markets
3(1) Instrument valuation
4Axioms underlying instrument valuation
5Issues with axioms
6Black-Scholes and generalisations
7Other derivative pricing models
8Model risk
9(2) Risk measurement
10At portfolio level
11Issues include
12Fat-tailed behaviour
13Selection effects, see e.g. Kemp (2010, 2010a, 2010b)
14Selection effects are potentially very important
15(3) Idea generation
16Techniques and characteristics
17(4) Portfolio construction, see Kemp (2010)
18Risk-return trade-off
19Why the sensitivity to input assumptions?
22Appendix: What causes fat-tailed behaviour
23Time-varying volatility
24Explains some market index fat tails, particularly on upside
25Not just a developed market phenomenon
26A longer term phenomenon too
27Time-varying volatility
28Regime switching
29Regime switching (continued)
30Crowded trades
32Other examples of leverage
33Impact that leverage can have on portfolio behaviour
34Important Information

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