Science in Finance: Introduction

Having for most of my quant career attacked the majority of mathematical modelling in finance for being ‘unscientific’ (in the sense that the theories are rarely tested before being used, and when tested usually fail miserably) I feel somewhat heartened by the recent anti-Black-Scholes movement.

Unfortunately this countermovement, although healthy in provoking debate, also does not quite match my (presumably rather high!) standards of rigour. With the aim of putting some science back into the quant debate I’m going to spend a few blogs highlighting what I think are the weaknesses of financial modelling, and its strengths. I will even be defending Black-Scholes at times! Being scientific does not mean being without emotion, so although my reasoning will be logical my language will almost certainly, and as always, get quite demonstrative.

Topics to look out for, in no particular order: supply and demand; accuracy in different markets; distributions and fat tails; volatility and robustness; hedging errors; diversification; correlation; etc.

In the meantime, listen to the recording of BBC Radio 4’s recent More or Less programmme which discusses what quants do in the context of recent market upsets. The podcast of this programme may be found here. (The quant section starts after 9mins 25 secs.)

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