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Pacman
Posts: 3
Joined: April 25th, 2006, 4:19 pm

What are the most important unsolved problems in finance today?

May 27th, 2006, 12:28 pm

Quote

Originally posted by: granchio
here's anothere one, which is the daily bread and butter of many traders:
how to price a vanilla 120% one year european call, (or 80% EP, whatever), on a liquid european stock with exitsting but illiquid option market (there are many of those).
Please assume that:
- there is one dividend expected, but neither date nor amount are officially confirmed
-similar instruments trades infrequently, it is sometimes possible to get quotes but they will be say 5 volpoints wide, and for very small size
- you either have to quote for
a) only bid or ask, but for 10 times the daily volume
b) both side, for 1/3 the daily volume,
and you have real political pressure from your bosses to win the trade or at least look good vs the competion, i.e. in (a) you have to be within 1 volpoint of the competition, in (b) you have to be 2 volpoint wide.

this is just to point out that our academic work remain focused on the need to fit our volsurfaces to the market, and predict the market smile dynamics, but in reality very often the problem is that there is no such thing as a market.


Hello Granchio, I have some naive questions for you. I would hardly find the answers in a paper
1- what is a 120% call? is it a moneyness ratio?
2- by 'daily volume' you mean the whole market volume on that option?
3- by 'competition' you mean that the client put other banks on the same deal? So you have to stay within 1 volpoint from which price? From the winning one? (i.e. the lowest ask price?)
4- In that case why do your boss want you to win the trade if not capping the 'right' volatility from now to maturity is much more dangerous for your book?

Can someone tell me if there is any book or paper wich explains options from the "operative" size?


Thank's a lot.


 
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bryang
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Joined: July 14th, 2002, 3:00 am

What are the most important unsolved problems in finance today?

June 29th, 2006, 2:38 pm

What proportion of market participants understand the models describing the consequences of their behavior?
 
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KackToodles
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Joined: August 28th, 2005, 10:46 pm

What are the most important unsolved problems in finance today?

September 9th, 2006, 8:16 am

How do I make a secret (legal) money machine?
Last edited by KackToodles on September 8th, 2006, 10:00 pm
 
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SW3Quant
Posts: 42
Joined: October 6th, 2006, 9:49 pm

What are the most important unsolved problems in finance today?

December 25th, 2006, 10:47 pm

RE: How to model liquidity?

Please find below an interesting paper on liquidity modelling:

http://www.sbs.gob.pe/Journal/volumen22/5SanjivR.pdf

Theoretical models of liquidity have been prevalent in the market microstructure literature for almost three decades. However, work aiming at incorporating the impact of market structure and illiquidity on the prices of financial instruments has a much briefer history.

What I have pondered whilst sitting on the loo is could it be possible to create any way of making money from predicting liquidity levels. So far my answer is no. Has this troubled anyone else?? Thoughts pls.
 
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flairplay
Posts: 130
Joined: September 26th, 2006, 1:34 pm

What are the most important unsolved problems in finance today?

December 30th, 2006, 7:02 am

Quote

Originally posted by: bryang
What proportion of market participants understand the models describing the consequences of their behavior?


As good a description as it gets. I suspect the number is very small.

Pure quants with no trading experience usually miss the intuition and understanding that develops from trading - or can develop. The average trader on the other hand either tends to disregard models too much or over-respect them. Even some of the better traders have so called intuition that is highly model specific. There are few who tend to have some understanding of both sides.

All models that don't incorporate non-linearity and liquidity are highly constrained. In real markets there is no such thing as linearity or perfect liquidity. As well, there is the question of availability of information (information asymmetry for the academically inclined).



 
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daaxix
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Joined: July 27th, 2007, 8:27 pm

What are the most important unsolved problems in finance today?

July 29th, 2007, 8:59 pm

Zhu from the University of Wollongong (Australia) has a closed form solution for the american put. See Noise and Fluctuations in Econophysics and Finance. Edited by Abbott, Derek; Bouchaud, Jean-Philippe; Gabaix, Xavier; McCauley, Joseph L. Proceedings of the SPIE, Volume 5848, pp. 186-199 (2005).
Last edited by daaxix on February 12th, 2015, 11:00 pm
 
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Alan
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What are the most important unsolved problems in finance today?

July 30th, 2007, 1:40 am

Yes, well ... some forum discussion here
 
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LiKaShing
Posts: 8
Joined: July 12th, 2007, 10:34 am

What are the most important unsolved problems in finance today?

August 7th, 2007, 8:12 am

Market Impact, see "Equity Market Impact", Risk 2006, by Almgren for an interesting approach.
Last edited by LiKaShing on August 7th, 2007, 10:00 pm
 
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jmonteiro
Posts: 21
Joined: July 14th, 2002, 3:00 am

What are the most important unsolved problems in finance today?

January 18th, 2008, 1:00 pm




The most important unsolved problem in today’s finance is "permanent irrational behaviour" of market participants.

Current crisis illustrates this problem once again pretty well.
Everyone knew CDOs and Co where a pure irrational product and, dispite that, every prop trading rooms were buying them (even Merrill traders!).
Now that they exploded everybody is attributing the fault to someone or something else (like sub-prime or Fed or recession).
CDO buyers created this crisis.
They are to blame.

Can finance theory solve this kind of problem?
 
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mathematalef0
Posts: 117
Joined: January 29th, 2007, 6:51 pm

What are the most important unsolved problems in finance today?

January 22nd, 2008, 7:54 am

Quote

Originally posted by: jmonteiro
The most important unsolved problem in today’s finance is "permanent irrational behaviour" of market participants.

Current crisis illustrates this problem once again pretty well.
Everyone knew CDOs and Co where a pure irrational product and, dispite that, every prop trading rooms were buying them (even Merrill traders!).
Now that they exploded everybody is attributing the fault to someone or something else (like sub-prime or Fed or recession).
CDO buyers created this crisis.
They are to blame.

Can finance theory solve this kind of problem?


I think even if someone could solve this problem, he wouldn't do it because that's the way profit is made. By taking advantage of other people irrationality! I like it that way
 
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exotiq
Posts: 1888
Joined: October 13th, 2003, 3:45 pm

What are the most important unsolved problems in finance today?

December 3rd, 2008, 9:27 pm

Quote

Originally posted by: mathematalef0
Quote

Originally posted by: jmonteiro
The most important unsolved problem in today’s finance is "permanent irrational behaviour" of market participants.

Current crisis illustrates this problem once again pretty well.
Everyone knew CDOs and Co where a pure irrational product and, dispite that, every prop trading rooms were buying them (even Merrill traders!).
Now that they exploded everybody is attributing the fault to someone or something else (like sub-prime or Fed or recession).
CDO buyers created this crisis.
They are to blame.

Can finance theory solve this kind of problem?


I think even if someone could solve this problem, he wouldn't do it because that's the way profit is made. By taking advantage of other people irrationality! I like it that way


It's a bit more complicated than that...

As far as CDOs, the products themselves were not irrational at all; they simply repackaged credit risk in a way that market participants who wanted to take more or less risk than 1:1 of the credit pool by buying / keeping only the slices that suited them best -- and as a result of this, the capital from these slice buyers became available to borrowers for whom credit markets were not so liquid before. What most arguably may have been the bigger problems / irrational steps in the CDO process (according to some at the time, but according to more in hindsight) were how these tranches were rated, how these rated pieces were treated by institutional mandates and regulations, or how they may have been used by investors who did not understand these concepts. The last point is simply a statement that there exist investors who buy financial instruments beyond their ability to understand them, which may be irrational, but does not say how big or significant a part of the market they are/were. The question of ratings and institutional treatment of these pieces did somewhat shake the foundations of trust in the system, and this shake-up mandates some changes and clean-up to evolve into the next step of financial innovation.

The bigger question of "permanent irrationality" can be far more interesting. Bubbles can be fascinating examples of "temporary irrationality", and extreme market depressions can be because of "temporarily irrational pessimism", lack of liquidity, or arguably a rational expectation of the possibility of a very gloomy future. I have seen these feed into a larger academic statement that markets are more volatile than they should be (the future earnings of the economy does not go up or down by hundreds of billions or trillions and back in a few days like markets trade them to). This sometimes leads to one of my favorite statements of "minimal rationality": prices are set irrationally, but that does not mean they are not efficient nor that there would be excess profit opportunities (leading to a separate discussion of whether those few who made money in busts are statistically significant, etc.). It is also worth debating what is rational or irrational behavior in a bubble or bust cycle: during this latest boom, people bought homes after seeing prices rise double digits for years not because they rationally thought prices would continue to do so, but because they were afraid that if they did, they would be priced out of the housing market and would not be able to afford a place to live - with real consequences to "buy now at any price while you can". Is it "irrational" for someone about to retire to continue to sell out of their risky assets now, or after they have fallen another 20%, for example?
 
mesk
Posts: 2
Joined: January 12th, 2018, 1:44 pm

Re: What are the most important unsolved problems in finance today?

February 9th, 2018, 11:52 am

A consistent method for cross currency swap pricing.
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