Financial econometrics

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Financial econometrics is the application of statistical methods to financial market data. [1] Financial econometrics is a branch of financial economics, in the field of economics. Areas of study include capital markets, [2] financial institutions, corporate finance and corporate governance. Topics often revolve around asset valuation of individual stocks, bonds, derivatives, currencies and other financial instruments.

Market data

In finance, market data is price and trade-related data for a financial instrument reported by a trading venue such as a stock exchange. Market data allows traders and investors to know the latest price and see historical trends for instruments such as equities, fixed-income products, derivatives, and currencies.

Financial economics is the branch of economics characterized by a "concentration on monetary activities", in which "money of one type or another is likely to appear on both sides of a trade". Its concern is thus the interrelation of financial variables, such as prices, interest rates and shares, as opposed to those concerning the real economy. It has two main areas of focus: asset pricing and corporate finance; the first being the perspective of providers of capital, i.e. investors, and the second of users of capital.

Economics Social science that analyzes the production, distribution, and consumption of goods and services

Economics is the social science that studies the production, distribution, and consumption of goods and services.

Contents

It differs from other forms of econometrics because the emphasis is usually on analyzing the prices of financial assets traded at competitive, liquid markets.

Econometrics is the application of statistical methods to economic data in order to give empirical content to economic relationships. More precisely, it is "the quantitative analysis of actual economic phenomena based on the concurrent development of theory and observation, related by appropriate methods of inference". An introductory economics textbook describes econometrics as allowing economists "to sift through mountains of data to extract simple relationships". The first known use of the term "econometrics" was by Polish economist Paweł Ciompa in 1910. Jan Tinbergen is considered by many to be one of the founding fathers of econometrics. Ragnar Frisch is credited with coining the term in the sense in which it is used today.

People working in the finance industry or researching the finance sector often use econometric techniques in a range of activities – for example, in support of portfolio management and in the valuation of securities. Financial econometrics is essential for risk management when it is important to know how often 'bad' investment outcomes are expected to occur over future days, weeks, months and years.

Investment management is the professional asset management of various securities and other assets in order to meet specified investment goals for the benefit of the investors. Investors may be institutions or private investors.

Risk management Set of measures for the systematic identification, analysis, assessment, monitoring and control of risks

Risk management is the identification, evaluation, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability or impact of unfortunate events or to maximize the realization of opportunities.

Topics

The sort of topics that financial econometricians are typically familiar with include:

In finance, arbitrage pricing theory (APT) is a general theory of asset pricing that holds that the expected return of a financial asset can be modeled as a linear function of various factors or theoretical market indices, where sensitivity to changes in each factor is represented by a factor-specific beta coefficient. The model-derived rate of return will then be used to price the asset correctly—the asset price should equal the expected end of period price discounted at the rate implied by the model. If the price diverges, arbitrage should bring it back into line. The theory was proposed by the economist Stephen Ross in 1976. The linear factor model structure of the APT is used as the basis for many of the commercial risk systems employed by asset managers.

Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of diversification in investing, the idea that owning different kinds of financial assets is less risky than owning only one type. Its key insight is that an asset's risk and return should not be assessed by itself, but by how it contributes to a portfolio's overall risk and return. It uses the variance of asset prices as a proxy for risk.

Cointegration is a statistical property of a collection (X1, X2, ..., Xk) of time series variables. First, all of the series must be integrated of order d. Next, if a linear combination of this collection is integrated of order less than d, then the collection is said to be co-integrated. Formally, if (X,Y,Z) are each integrated of order d, and there exist coefficients a,b,c such that aX + bY + cZ is integrated of order less than d, then X, Y, and Z are cointegrated. Cointegration has become an important property in contemporary time series analysis. Time series often have trends—either deterministic or stochastic. In an influential paper, Charles Nelson and Charles Plosser (1982) provided statistical evidence that many US macroeconomic time series have stochastic trends—these are also called unit root processes, or processes integrated of order . They also showed that unit root processes have non-standard statistical properties, so that conventional econometric theory methods do not apply to them.

Research community

The Society for Financial Econometrics (SoFiE) [5] is a global network of academics and practitioners dedicated to sharing research and ideas in the fast-growing field of financial econometrics. It is an independent non-profit membership organization, committed to promoting and expanding research and education by organizing and sponsoring conferences, programs and activities at the intersection of finance and econometrics, including links to macroeconomic fundamentals. SoFiE was co-founded by Robert F. Engle and Eric Ghysels.

Robert F. Engle American economist

Robert Fry Engle III is an American statistician and the winner of the 2003 Nobel Memorial Prize in Economic Sciences, sharing the award with Clive Granger, "for methods of analyzing economic time series with time-varying volatility (ARCH)".

Eric Ghysels is a Belgian economist with particular interest in finance and time series econometrics who works in the field of financial econometrics, and is currently the Edward M. Bernstein Distinguished Professor of Economics at the University of North Carolina and a Professor of Finance at the Kenan-Flagler Business School.

Premier-quality journals which publish financial econometrics research include Econometrica, Journal of Econometrics and Journal of Business & Economic Statistics. The Journal of Financial Econometrics [6] has an exclusive focus on financial econometrics. It is edited by Federico Bandi and Andrew Patton, and it has a close relationship with SoFiE.

Econometrica is a peer-reviewed academic journal of economics, publishing articles in many areas of economics, especially econometrics. It is published by Wiley-Blackwell on behalf of the Econometric Society. The current editor-in-chief is Joel Sobel.

The Journal of Econometrics is a scholarly journal in econometrics. It was first published in 1973. Its current editors are A. Ronald Gallant, John Geweke, Cheng Hsiao, and Peter M. Robinson.

The Journal of Business & Economic Statistics is a quarterly peer-reviewed academic journal published by the American Statistical Association. The journal covers a broad range of applied problems in business and economic statistics, including forecasting, seasonal adjustment, applied demand and cost analysis, applied econometric modeling, empirical finance, analysis of survey and longitudinal data related to business and economic problems, the impact of discrimination on wages and productivity, the returns to education and training, the effects of unionization, and applications of stochastic control theory to business and economic problems.

The Nobel Memorial Prize in Economic Sciences has been awarded for significant contribution to financial econometrics; in 2003 to Robert F. Engle "for methods of analyzing economic time series with time-varying volatility" and Clive Granger "for methods of analyzing economic time series with common trends" [7] and in 2013 to Eugene Fama, Lars Peter Hansen and Robert J. Shiller "for their empirical analysis of asset prices". [8] Other highly influential researchers include Torben G. Andersen, Tim Bollerslev and Neil Shephard. [9]

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In financial economics, asset pricing refers to a formal treatment and development of two main pricing principles, outlined below, together with the resultant models. There have been many models developed for different situations, but correspondingly, these stem from general equilibrium asset pricing or rational asset pricing, the latter corresponding to risk neutral pricing.

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Kenneth Jan Singleton is an American economist. He is a leading figure in empirical financial economics, and a faculty member at Stanford University.

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References

  1. ↑ Brooks, Chris (2014). Introductory Econometrics for Finance (3rd ed.). Cambridge: Cambridge University Press. ISBN   9781107661455.
  2. ↑ Campbell, John; Lo, Andrew; MacKinlay, Andrew (1997). The Econometrics of Financial Markets. Princeton: Princeton University Press. ISBN   9780691043012.
  3. ↑ Taylor, Stephen (2005). Asset Price Dynamics, Volatility, and Prediction. Princeton: Princeton University Press. ISBN   9780691134796.
  4. ↑ Wang, Peijie (2003). Financial Econometrics: Methods and Models. Routledge. ISBN   978-0-415-22455-0.
  5. ↑ "{title}". Archived from the original on 2012-11-17. Retrieved 2012-11-10.
  6. ↑ "{title}". Archived from the original on 2009-11-24. Retrieved 2009-12-02.
  7. ↑ "{title}". Archived from the original on 2017-06-02. Retrieved 2017-06-13.
  8. ↑ "{title}". Archived from the original on 2017-06-02. Retrieved 2017-06-13.
  9. ↑ https://scholar.google.co.uk/citations?view_op=search_authors&hl=en&mauthors=label:financial_econometrics
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