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Machine Learning for Quantitative Finance
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Lab - Quantitative Finance
The financial industry consists of three sectors: asset management, banking, and insurance. The ultimate goal of each operator in the industry, regardless of the sector, is to win the risk/return battle.
To reach the ultimate goal, the financial industry has set in place tightly connected, sequential functions, which can be summarized in a "Checklist": ten sequential steps, clustered in three parts, to model, assess, and improve the performance of the portfolio/firm.
Accordingly, the Lab's coverage of quantitative finance is divided into the following parts:
- Financial Engineering: steps 1-4 of the "Checklist", which discuss how to price instruments across asset classes, and how to estimate from data the joint distribution of their future payoff;
- Portfolio and Enterprise Risk Management: steps 5-7 of the "Checklist", which discuss how to aggregate the future payoff of each instrument into future payoff of a given portfolio and how to assess the risk in that portfolio, at the fund, desk, or enterprise level;
- Portfolio Construction and Trading: steps 8-10 of the "Checklist", which discusses how to construct theoretical portfolios or investment strategies, how to optimally execute trades, and how to assess past realized performance.
In the figure we summarize the steps of the "Checklist".
Financial Engineering
Financial Engineering covers Steps 1-4 of the "Checklist".
Step 1 discusses how to price instruments across asset classes by means of the so-called risk-neutral or "Q" measure, as well as variations such as the CAPM or the APT.
Step 2 discusses how to convert raw financial data into well-behaved times series.
Step 3 discusses how to use econometric tools to model and estimate the evolution of such time series in the so-called real world or "P" measure.
Step 4 discusses how to map the future evolution of the time series back into the object of interest, which is joint distribution of the instruments future payoff.
This part covers the below portion of the "Quantitative Finance Checklist".
Portfolio and Enterprise Risk Management
Portfolio and Enterprise Risk Management covers Steps 5-7 of the "Checklist":
Step 5 discusses how to compute the aggregate value of a given portfolio, based on the portfolio's holdings; and how to aggregate the future payoff of each instrument into the future payoff of the portfolio under regular and stress market conditions.
Step 6 discusses how to assess the overall risk in a given portfolio at the fund, desk, or enterprise level.
Step 7 discusses how to attribute the overall risk to the contribution of different factors.
This part covers the below portion of the "Quantitative Finance Checklist".
Portfolio Construction and Trading
Portfolio Construction and Trading covers Steps 8-10 of the "Checklist".
Step 8 discusses how to construct theoretical static portfolios based on mean-variance optimization or more complex algorithms; and to build dynamic investment strategies based on cross sectional heuristics or option based portfolio insurance.
Step 9 discusses how to implement a theoretical allocation in practice by optimally scheduling small orders in an electronic exchange.
Step 10 discusses how to assess past realized performance and attribute profits and losses to different contributors.
This part covers the below portion of the "Quantitative Finance Checklist".