The applications of copulas in quantitative finance are numerous, both in the real-world probability of risk/portfolio management and in the risk-neutral probability of derivatives pricing.
In risk/portfolio management, copulas are used to perform stress-tests and robustness checks: panic copulas are glued with market estimates of the marginal distributions to analyze the effects of panic regimes on the portfolio profit and loss distribution. Panic copulas are created by Monte Carlo simulation, mixed with a re-weighting of the probability of each scenario.
As far as derivatives pricing is concerned, dependence modelling with copula functions is widely used in applications of financial risk assessment and actuarial analysis – for example in the pricing of collateralized debt obligations (CDOs). Some believe the methodology of applying the Gaussian copula to credit derivatives to be one of the reasons behind the global financial crisis of 2008–2009. Despite this perception, there are documented attempts of the financial industry, occurring before the crisis, to address the limitations of the Gaussian copula and of copula functions more generally, specifically the lack of dependence dynamics and the poor representation of extreme events. There have been attempts to propose models rectifying some of the copula limitations.
While the application of copulas in credit has gone through popularity as well as misfortune during the global financial crisis of 2008–2009, it is arguably an industry standard model for pricing CDOs. Less arguably, copulas have also been applied to other asset classes as a flexible tool in analyzing multi-asset derivative products. The first such application outside credit was to use a copula to construct an implied basket volatility surface, taking into account the volatility smile of basket components. Copulas have since gained popularity in pricing and risk management of options on multi-assets in the presence of volatility smile/skew, in equity, foreign exchange and fixed income derivative business. Some typical example applications of copulas are listed below:
- Analyzing and pricing volatility smile/skew of exotic baskets, e.g. best/worst of;
- Analyzing and pricing volatility smile/skew of less liquid FX cross, which is effectively a basket: C = S1/S2 or C = S1*S2;
- Analyzing and pricing spread options, in particular in fixed income constant maturity swap spread options.
Other articles related to "quantitative, finance, quantitative finance":
... is to teach a range of business programs that incorporate a real-world perspective, analytic/quantitative skills, the relationship between business and technology, and the multidisciplinary components of ... addition to the MBA, Stuart offers interdisciplinary programs such as Mathematical Finance, Marketing Analytics Communication, Public Administration, and Environmental Management and Sustainability in ... program in Operations with concentrations in Finance and Management ...
... A masters degree in quantitative finance concerns the application of mathematical methods to the solution of problems in financial economics ... degrees which may further focus on financial engineering, financial risk management, computational finance and/or mathematical finance ... to prepare students for roles as "quants" (quantitative analysts), including analysis, structuring, trading, and investing in particular, these degrees emphasize derivatives and fixed income, and the hedging and ...
... qualifications, that can lead to the field Generalist Finance qualifications Degrees Masters degree in Finance (MSF), Master of Financial Economics, Master of Finance Control (MFC ...
Famous quotes containing the word finance:
“A bank is a confidence trick. If you put up the right signs, the wizards of finance themselves will come in and ask you to take their money.”
—Christina Stead (19021983)