What is quantitative finance
In recent years quantitative finance has become a very hot field. All of the big investment houses are pouring millions of dollars in to it as they look to improve their trading record. Most people really have no idea what quantitative finance entails, which is largely because of the very complicated nature of what they do.
Quantitative finance is the discipline of using mathematical models in order to help make investment decisions. In a lot of ways the field is related to economics but the work is done from more of an applied perspective. In recent years investment firms have put a lot of effort into developing these models in order to improve their trading. That being said the results have been somewhat varied because none of the models have been able to factor in all of the variables. Nevertheless quantitative finance does seem likely to become even more widespread in the future.
There are basically two main areas in which quantitative finance works, the first is derivative pricing. In recent years derivatives have become widely traded, much more widely traded than the actual stocks. A big part of the reason for this is that through the work of quantitative finance specialists there is now a way to price them. This is particularly true of options in which the price is determined by the expected future value of a stock. The ability to determine what the price of an option should be has made it much less risky to trade them which is a big part of why they have become so popular.
The other area where a great deal of work is done in quantitative finance is in asset allocation. This focuses on how to get the best return for the least amount of risk. This is done largely through careful selection of the assets in your portfolio. For a time there was a belief that they could create a model that allowed for a profit to be earned with no risk if you choose the right combination of assets. This turned out to not true so the focus now is mainly on determining just how much risk there actually is.
Recently quantitative finance has started to fall a little bit out of favour. It is still widely used to be sure but it has lost some credibility. This is mainly because of the current global financial crisis which none of the models predicted. The main reason for this is that most models are based on historically data but few of them went back far enough. As a result the models were based on an unusually strong period in the markets which gave a false impression. Quantitative finance will continue to play an important role in the future but it is clear that they will have to come up with better models.