Part three of three 'Finance Focus' recordings, this with John Holden, David Sayers & Robert Tong from the NAG Quant Event in London, October 2009

Part two of three 'Finance Focus' recordings, this with Mike Giles, from the NAG Quant Event in London, October 2009

Part one of three 'Finance Focus' recordings, this with Nick Higham, from the NAG Quant Event in London, October 2009

Computational Finance is, in our understanding, the art of modelling financial processes and then to somehow calculate fair values of financial instruments.

There are intrinsically several traps which one should avoid: Different models for the underlying lead to different prices of derivatives. When models get too complicated, there is the danger of spurious accuracy, which may lead to a loss of criticism. Numerical methods for the valuation have to be chosen in such a way that they can handle the problem under consideration reasonably fast, stable and robust, ideally also for the Greeks.

In the calibration of models, there is the danger of local minima or of instabilitites when many parameters have to be identified.

We will give examples of risky horrors during the presentation.

With the age of multi-core having fully arrived, and with many-core processors just around the corner, quantitative analysts are in need of software tools that allow them to harness the computational capabilities and memory capacity of parallel systems. In this presentation, we provide an overview of the Star-P parallel computing platform and its possible uses in quantitative finance for problems with large distributed data sets and task parallel operations. Recent additions to Star-P will be highlighted that have direct benefit to financial modeling problems, including the addition of Statistics and Optimization function libraries, and the integration of Star-P with the Tomlab Optimization platform. A demo of Star-P will also be included in the presentation.

In an age in which commercial quantitative tools are both powerful and affordable, quantitative analysis is often limited by data considerations. An increase in the ease and speed with which data can be incorporated can enhance productivity and lead to better research. In this presentation we review some typical quantitative data storage requirements, and some possible solutions. We illustrate an approach developed at OMAM which uses a novel relational database schema to provide outstanding performance. Mike Servent is Head of Quantitative & Modelling Systems at Old Mutual Asset Managers, UK. His team forms part of the Quantitative Strategies Group at OMAM which runs Global Equity Market-Neutral and Long-only funds with approx $ 2.5 billion AUM. The team provides quantitative platforms including statistical packages, optimisers, databases and reporting systems, as well as OMAM's proprietary quant models. Previously Mike has worked at MSCI Barra and at BITA Risk.

The Numerical Algorithms Group (NAG), Wilmott and 7city hosted a city seminar for finance industry professionals on 21st February 2008.

This talk is an attempt to understand the equity, commodity, currency, real estate, fixed income and other markets in 2007/8 tracing them from the mid 1990s. The speaker has been a trader, money manager and researcher since 1980 focusing on equity, commodity and currency markets. He is active in real estate and studies the impact of fixed income and interest rate markets on these areas. There is currently a mixture of sound economics moving in negative directions in real estate and the equity markets plus a large fear of the unknown from reported and unreported subprime losses.

Jump diffusion based models have recently increased in popularity. In this article, we develop robust and efficient techniques for the numerical solution of option pricing.

In a finite element framework, we analyze the pricing of cross-currency convertible bonds where the underlying share is denominated in a currency foreign to the convertible bond issue. Especially of interest are the cases where this two-dimensional problem cannot be reduced to one dimension.

The basic problem of economics is to take a given set of assets, skills and preferences for a group and organize the optimal activities according to some preference aggregation function. The field of finance is responsible for designing tools to help in this process. Money is an early tool. You assign a weight to every input and potential output, and ask each member of the group to do a one-dimensional linear local optimization. You shower all good things on the members who do this well, and grind the ones who do it badly into misery. The results of these local optimizations feed back into the weight assignments which makes the process high dimension and nonlinear, even though individuals only have to solve univariate linear problems. The approach works well when things are smooth and there a unique global optimum, but if not it can be unstable or get stuck in unpleasant local optimums. Central planning is a tempting approach to mathematical modelers because in principle it can solve the global multidimensional nonlinear problem. It allows the organization of activity to be solved independently of the distribution of outputs, less showering, less misery. It has a reputation for failure, but perhaps with recent advances in applied mathematics combined with more powerful computers it could now outperform money. The game of poker is another approach and I will argue it was responsible for more economic progress in the 19th century than the money economy and that it has popped up in interesting ways at key points of the 20th century. Derivatives trading, which evolved from poker games, is another approach. Rather than have lots of people solve low-dimensional linear local problems, it asks a small group of people to solve higher dimensional nonlinear global problems. The feedback loop is multidimensional and also higher frequency than with money. Showering of good things and misery are still allocated according to optimization skills, and in an exaggerated manner, but only for the trading group. I will discuss the pros and cons of these approaches from the standpoint of mathematical programming (i.e. considerations of social justice, human happiness and morality were reserved for post-talk drinks).

We introduce a practical alternative to Gaussian risk factor distributions based on Svetlozar Rachev's extensive work on Stable distributions in Finance (see Rachev and Mittnik, 2000), and called the  Paradigm..

Stochastic volatility models usually lead to a linear option pricing equation containing a market price of risk term. This term is the source of endless problems and argument.

Espen Haug's lecture on Asian Pyramid Power can be seen inside, once you are logged in. (You will be asked to download WebEx software.)

Aaron Brown looks at the curious evolution of Poker.

Aaron's book "The Poker Face of Wall Street" has recently been published by Wiley. The book is available in the bookshop and is under discussion in the Forum.

The funds that were meant to suck, metaphorically.

Hedging strategies for derivatives which are considered in theory and applied in practice are understood to perform self-financing and to duplicate the final payoff. Of course, this is only valid with respect to an assumed model, called "hedging model", which specifies a set of postulates about the evolution of the underlying stock prices.

This paper discusses European option pricing under various discontinuous conditions: option and underlying prices as well as volatility and drift coefficients experience breaks. We consider vanilla and double-barrier options under double-exponential jump diffusion model with jump drift and jump volatility. Our approach consists in applying Laplace transform directly to the pricing equation with further computing option prices and risk parameters via numerical inversion of their Laplace transforms. We focus on simple close-form and quasi-close-form solutions.

Outside Double Barrier Options are two-asset options where the payoff is defined on one asset and the barrier is defined on another asset. This paper gives the formulas for Outside Double Barrier Options where the barrier is either plain or partially monitored at the front, rear and middle. Since the corresponding Outside Single Barrier Options prices can be written down by taking the corresponding upper (lower) barrier to infinity (zero), the formulas in this paper can be also used as a reference for Outside Single Barrier Options. Crude approximations for the discretely observed barrier cases are also discussed.

Asian Options, also known as "Average Options", are options whose payments at maturity depends on a-in real world-discretely monitored average of stock prices. There are two basic types of Asian Options: Fixed Strike Options (syn. Average Price Options, Average Rate Options) and Floating Strike Option (syn. Average Strike Options). The first type pays at maturity the difference-if positive-between some arithmetic mean of the stock and a predetermined strike price. The second type pays at maturity the difference-if positive-between the arithmetic mean and the stock price at maturity. Asian Options are normally European-style options. It is not possible to derive an (exact) closed-form solution in the Black-Scholes model, since the sum of log-normally distributed random variables is not log-normal.

Pulp fiction may not seem a natural place to find nuggets of economic thought but Jim Thompson's work contains some financial gems worth examining.

The word martingale is definitely among the most used words in mathematical finance, a fact which is due to the fundamental importance of martingale measures in connection with option pricing. However, this subject will not be touched here. The area of application where this article is centered around is not pricing but optimal behaviour of an individual at a financial market or at any area where decisions about control actions have to be taken such as looking for optimal investment strategies, steering an airplane in an efficient way, or searching for the optimal velocity of a production line.

How to lose money in derivatives, oh and how to make it fast too.

In this article we present an introduction to various Filtering algorithms and some of their applications to the world of Quantitative Finance. We shall first mention the fundamental case of Gaussian noises where we obtain the well-known Kalman Filter.

Because of common nonlinearities, we will be discussing the Extended Kalman Filter

'Finance Focus' event organised by Wilmott magazine and 7city and sponsored by d-fine presented by Elie Ayache of ITO33:

How can derivative pricing be founded when the derivative pricing models all rely on a fixed collection of states of the world (e.g. values of the underlying, or other state variables) and the subsequent trading of those derivatives in fact never stops expanding the collection of states of the world? For instance, Black-Scholes assumes the underlying as sole state variable, yet trading options with Black-Scholes will almost certainly create new states of the world, i.e. stochastic implied volatility. Like all the sciences falling under the umbrella of the metaphysics of presence, option pricing theory cannot avoid this schema. There can be no foundation without presence. Yet the bigger picture of derivative pricing-AND-trading (in other words, the full story of calibration AND recalibration) is here to teach us that there is a non-foundation below the foundation, what we would call, following Derrida, the "non-Greek" non-foundation. Once we start looking at the derivatives from a non-foundational, i.e. deconstructed, point of view, it might appear to us that they are less derivative and more primordial to our overall understanding of the market than we think.

About Elie Ayache: Elie Ayache graduated from Ecole Polytechnique in 1987. He then held a position at Banque Indosuez in Paris as one among the first option traders on the floor of MATIF. In 1990, Elie, co-founded Transoptions Finance, a subsidiary of Credit Agricole, which specialised in option market making. He personally stood on the floor of LIFFE, in the Bund option pit, until 1995. From 1996 to 1998, Elie headed the R&D of Dexia Asset Management in Paris, where he developed derivatives pricing models. In 1998, Elie created ITO33, a software company specialising in mathematical models and numerical solutions for derivative instruments, particularly Convertible Bonds and volatility smiles.

Martha Stewart beware! This instalment of the Reverending (sic) story revisits our robotic coin tossing friend and really puts Bayes through his paces.

For all his genius, Einstein never accepted the uncertainty inherent in quantum theory."  I just cannot believe that God would choose to play dice with the universe," he said. This statement endeared Einstein to modern physicists more than anything else he ever said, because it gave even the lowliest grad student an opportunity to feel brighter and less dogmatic than Einstein.

And the Nobel Prize for Prescience goes to... Wilmott Magazine. As you are all no doubt aware, one of this year's winners of the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel is Robert F Engle.

We aren't ones to bask in reflected glory and don't wish to detract from the ARCH-economist's achievement, but in the May 2003 issue of Wilmott we did indeed predict that such a thing would come to pass. So permit us to spruce up our own set of laurels and present for your consideration the story that allows us now to say, we told you so...

Magazine Subscribers Only

Espen Gaarder Haug's Finance Focus talk on "Asian Pyramid Power" at the Financial World Bookshop can now be seen by magazine subscribers inside the dedicated magazine area on wilmott.com. Once in the magazine area, scroll down to the latest Epsen Gaarder Haug article where you will find the link.

Once again we would like to thank 7city

"The demand for education in quantitative finance has never been greater, however, the ability to supply a high-quality program to satisfy that demand is as limited as ever. In putting together this Certificate we are aiming to be the best. We have focused on finding the most experienced lecturers, and the most relevant and up-to-date content. This is then provided in the most convenient and accessible manner."

The course is delivered in London and live over the internet.

Find out more about the program, sign up for the CQF Open Day, watch a lecture on 'The Binomial Method' and download the full brochure in pdf format.

Investment in emerging markets has become a prominent feature of the financial globalization sweeping the world. Besides market risk, however, investments in emerging markets are also exposed to political phenomena that are not generally present in the more developed economies.

The Mexican peso crisis and the Asian economic
meltdown are two of the more spectacular examples.This problem is well known to banks and multinational companies by the name of country or political risk and, although assessment techniques in these domains are relatively well developed, they are not really adapted to economic and financial risk management.

My 11-year old son complains bitterly almost every night about homework (his eight-year old brother isn't old enough for homework yet, which is especially infuriating).   Although he doesn't like any homework, he's especially unhappy when it's math, his least favorite subject.

According to his teachers, he does very well in the subject, but he's convinced he's not any good at it.

Share our passion for great writing - with Wiley's new list of titles for independent thinkers.

When you subscribe to Wilmott magazine you will automatically become a member of the Wilmott Book Club and will be eligible for 40 per cent discount on specially selected Wiley books in each issue. The titles will
range from finance to narrative non-fiction.

In the Book Club this month...

Swaps and Other Derivatives by Richard Flavell

Paul Wilmott On Quantitative Finance

Behavioural Finance: A User's Guide by James Montier

Measuring Market Risk by Kevin Dowd

Equity Derivatives: Theory and Applications by Marcus Overhaus, Andrew
Ferrraris, Thomas Knudsen, Ross Milward, Laurent Nguyen-Ngoc and Gero
Schindlmayr

and many more...

It has been forty years since the first edition of Beat the Dealer was published in November, 1962.  This led Paul Wilmott to ask me if I'd like to write a few words for the website.

In natural gas markets,demand exhibits low price elasticity,while supply follows the market price;a phenomenon typically observed in markets for indispensable goods.

A significant portion of gas consumption is due to heating and increasingly power generation, which sets a typical demand pattern:high in winter and summer ('high'seasons) and low in shoulder months ('low'seasons).

The year is 1938. The place, about 45 miles out of Chicago.

On the steps of a market a boy of not quite six faces off against a perplexed looking local man who holds a heavy tome belonging to the kid, and studies it with some skepticism.

There seems little point in beating about the bush - it's easy to improve the accuracy of the standard binomial models for valuing equity options and yet very few people know how. So banish your Cox, Ross & Rubinstein (or Jarrow & Rudd) models and replace them with the Leisen & Reimer model - just paste the accompanying VBA functions into a new module sheet.

One of our most successful quizzes, in terms of responses, but not exactly what you'd call successful in terms of answers.

There are 10 pirates in a rowing boat. Their ship has just sunk but they managed to save 1000 gold doubloons. Being greedy bastards they each want all the loot for themselves but they are also democratic and want to make the allocation of gold as fair as possible. But how?

Can anyone get their answer in before our good friend Aaron Brown?

Despite our valiant attempts to defeat him, Aaron Brown could not be beat. Time Series A was indeed the real one. Here is AB's answer...

After keeping you on tenterhooks... it is time to find out whether you should walk the plank