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Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, which is the study of production, distribution, and consumption of money, assets, goods and services . Finance activities take place in financial systems at various scopes, thus the field can be roughly divided into personal, corporate, and public finance.
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 share prices, interest rates and exchange rates, 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. It thus provides the theoretical underpinning for much of finance.
Value at risk (VaR) is a measure of the risk of loss for investments. It estimates how much a set of investments might lose, given normal market conditions, in a set time period such as a day. VaR is typically used by firms and regulators in the financial industry to gauge the amount of assets needed to cover possible losses.
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.
In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to the risk associated with any one individual entity, group or component of a system, that can be contained therein without harming the entire system. It can be defined as "financial system instability, potentially catastrophic, caused or exacerbated by idiosyncratic events or conditions in financial intermediaries". It refers to the risks imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire system or market. It is also sometimes erroneously referred to as "systematic risk".
Financial risk management is the practice of protecting economic value in a firm by managing exposure to financial risk - principally operational risk, credit risk and market risk, with more specific variants as listed aside. As for risk management more generally, financial risk management requires identifying the sources of risk, measuring these, and crafting plans to address them. See Finance § Risk management for an overview.
Financial risk is any of various types of risk associated with financing, including financial transactions that include company loans in risk of default. Often it is understood to include only downside risk, meaning the potential for financial loss and uncertainty about its extent.
Financial modeling is the task of building an abstract representation of a real world financial situation. This is a mathematical model designed to represent the performance of a financial asset or portfolio of a business, project, or any other investment.
The following outline is provided as an overview of and topical guide to finance:
Skewness risk in financial modeling is the risk that results when observations are not spread symmetrically around an average value, but instead have a skewed distribution. As a result, the mean and the median can be different. Skewness risk can arise in any quantitative model that assumes a symmetric distribution but is applied to skewed data.
Simply stated, Post-Modern Portfolio Theory (PMPT) is an extension of the traditional Modern Portfolio Theory (MPT) of Markowitz and Sharpe. Both theories provide analytical methods for rational investors to use diversification to optimize their investment portfolios. The essential difference between PMPT and MPT is that PMPT emphasizes the return that must be earned on an investment in order to meet future, specified obligations, MPT is concened only with the absolute return vis-a-vis the risk-free rate.
In finance, volatility is the degree of variation of a trading price series over time, usually measured by the standard deviation of logarithmic returns.
In financial mathematics, a risk measure is used to determine the amount of an asset or set of assets to be kept in reserve. The purpose of this reserve is to make the risks taken by financial institutions, such as banks and insurance companies, acceptable to the regulator. In recent years attention has turned towards convex and coherent risk measurement.
In finance, model risk is the risk of loss resulting from using insufficiently accurate models to make decisions, originally and frequently in the context of valuing financial securities. However, model risk is more and more prevalent in activities other than financial securities valuation, such as assigning consumer credit scores, real-time probability prediction of fraudulent credit card transactions, and computing the probability of air flight passenger being a terrorist. Rebonato in 2002 defines model risk as "the risk of occurrence of a significant difference between the mark-to-model value of a complex and/or illiquid instrument, and the price at which the same instrument is revealed to have traded in the market".
In financial econometrics, the Markov-switching multifractal (MSM) is a model of asset returns developed by Laurent E. Calvet and Adlai J. Fisher that incorporates stochastic volatility components of heterogeneous durations. MSM captures the outliers, log-memory-like volatility persistence and power variation of financial returns. In currency and equity series, MSM compares favorably with standard volatility models such as GARCH(1,1) and FIGARCH both in- and out-of-sample. MSM is used by practitioners in the financial industry to forecast volatility, compute value-at-risk, and price derivatives.
Portfolio optimization is the process of selecting the best portfolio, out of the set of all portfolios being considered, according to some objective. The objective typically maximizes factors such as expected return, and minimizes costs like financial risk. Factors being considered may range from tangible to intangible.
Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling of financial markets.
Financial correlations measure the relationship between the changes of two or more financial variables over time. For example, the prices of equity stocks and fixed interest bonds often move in opposite directions: when investors sell stocks, they often use the proceeds to buy bonds and vice versa. In this case, stock and bond prices are negatively correlated.
Kevin Dowd is a British economist, having research interests in private money and free banking, monetary systems and macroeconomics, financial risk measurement and management, risk disclosure, political economy and policy analysis, and pensions and mortality modelling. As of this date, he is a partner in Cobden Partners based in London, and Professor of Finance and Economics at Durham University Business School.
References
- 1 2 Nassim Nicholas Taleb (2007). The Black Swan: The Impact of the Highly Improbable. Random House. ISBN 978-1-4000-6351-2.
- ↑ Benoît Mandelbrot and Richard L. Hudson (2006). The Misbehavior of Markets: A Fractal View of Financial Turbulence. Basic Books. ISBN 978-0-465-04357-6.
- ↑ Alan Greenspan (2008-03-17). "We will never have a perfect model of risk". Financial Times . Retrieved 2009-07-18.
- ↑ "Financial economics: Efficiency and beyond". The Economist . 2009-07-16. Retrieved 2009-07-18. From The Economist print edition.
- ↑ Jokhadze, Valeriane; Schmidt, Wolfgang M. (2018). "Measuring model risk in financial risk management and pricing". SSRN. doi:10.2139/ssrn.3113139. S2CID 169594252.
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