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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
Slides
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Modelling in financial markets
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Modelling in financial markets
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(1) Instrument valuation
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Axioms underlying instrument valuation
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Issues with axioms
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Black-Scholes and generalisations
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Other derivative pricing models
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Model risk
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(2) Risk measurement
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At portfolio level
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Issues include
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Fat-tailed behaviour
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Selection effects, see e.g. Kemp (2010, 2010a, 2010b)
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Selection effects are potentially very important
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(3) Idea generation
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Techniques and characteristics
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(4) Portfolio construction, see Kemp (2010)
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Risk-return trade-off
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Why the sensitivity to input assumptions?
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Summary
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References
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Appendix: What causes fat-tailed behaviour
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Time-varying volatility
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Explains some market index fat tails, particularly on upside
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Not just a developed market phenomenon
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A longer term phenomenon too
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Time-varying volatility
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Regime switching
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Regime switching (continued)
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Crowded trades
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Leverage
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Other examples of leverage
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Impact that leverage can have on portfolio behaviour
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Important Information
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