Quantitative finance: mathematical models serving the finance sector. Interview with Yann Braouezec
IÉSEG has just launched a new research center dedicated to the topic of quantitative finance, a discipline that provides essential knowledge and techniques for the financial sector. The Director of this center (iℚuant), Yann BRAOUEZEC, explains the importance and key aspects of this discipline, the objectives and key activities of iℚuant.
04/25/2023
7 min
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Could you please define exactly what we mean when we talk about quantitative finance?
Quantitative finance refers to the use of mathematical models (simple or complex) to evaluate, using a scientific approach, certain characteristics of financial instruments such as stocks or bonds. To understand the role and the interest of using such models, I can highlight two examples of important parameters for banks. The first is the probability of default (i.e., the likelihood that a borrower will be unable to meet its debt obligation) and the second is what we refer to as volatility.
If we consider the example of a zero-coupon bond. A bond that promises a return of one euro in one year, the maturity date, is today sold at a price of less than one euro. An investor who buys this bond today will receive one euro in one year if the seller does not default. However, in the case of a default, the investor will generally receive an amount less than one euro, i.e. he will receive an amount R which is a number between zero and one but which is not known today.
From the investor’s point of view (say, a traditional bank) who seeks to evaluate his “potential” loss over a one-year horizon, he/she must therefore quantify the chances — a number p between zero and one — that the seller will default. In finance, this number p is called a probability of default (at one year) and its quantification requires the use of a mathematical model. When you think about it, quantifying the risk of default is actually the core business of banks, since their core business is collecting deposits (and providing related payment services) and lending to households and (small and medium-sized) businesses. For large banks such as BNP Paribas or Société Générale, the value of loans to customers is several hundred billion euros. To obtain an evaluation of the different probabilities of default concerning their customers, banks often use different types of mathematical models (statistical models, scores….).
In market finance, meanwhile, the best-known parameter is volatility, which represents the standard deviation of annual rates of return. A rate of return is simply a percentage.
Thus, an annual rate of return of 3% means that a financial product such as a share bought for 100 euros will be worth 103 euros in one year. However, it is risky to assert that the rate of return on a particular share will certainly be 3% in one year. It is more realistic to say that, on the basis of past (share) price observations, this rate of return in one year will be 3% on average. This means that there can be deviations from this average of 3% and volatility is precisely a measure of these deviations from the average. The basic problem in market finance is that this volatility is not constant over time. If it were, like a number of parameters in physics, things would be much simpler! In general, in times of “crisis” (financial, health, war, etc.), this volatility tends to increase strongly. Now, some financial products sold by banks such as derivatives depend strongly on this volatility. A poor estimation of this volatility when selling a derivative product could therefore lead to important losses.
One of the objectives of quantitative finance is therefore the analysis of mathematical (and statistical) models for the measurement and management of financial risks.
Why did you decide to launch the center now and what will be its main objectives?
Finance is a vast discipline that brings together within the IÉSEG Finance Department professors with very different skills and areas of expertise. In terms of research, it was therefore very natural to “segment” the department into smaller, homogeneous teams in order to facilitate (research) collaboration. Iℚuant will therefore focus more specifically on quantitative finance. There are many very important topics to study such as the evaluation of the economic and financial consequences of global warming, digital currencies and central banks, systemic risk and banking regulation etc…
The launch of the iℚuant center takes place on Wednesday March 22, 2023 and the speaker, Olivier De Bandt, Director of Research at the Bank of France, gives us a presentation on the macroeconomic consequences of global warming.
The missions of iℚuant are twofold – to support research activities in the field of quantitative finance, but also to support the dissemination of this research to stakeholders. On the one hand we will organize seminars and workshops for a public of specialized researchers and on the other we will organize iℚuant evenings for a wider public from the socio-economic world including professionals from the financial sector or policy makers.
Are there any trends in the field of quantitative finance that we should observe over the next 12 months?
Indeed, iℚuant is dedicated to organizing events on important topical issues in quantitative finance. The topics can of course be chosen according to the most recent news. For example, the topic of central bank digital currencies (CBDC) is an important one and the Central Bank has not yet fully decided what its central bank digital currency will be. Another important topic in 2023 will be related to the recent news of the possible return of systemic risk following the bankruptcy of the American bank SVB and the takeover of Credit Suisse by UBS.
How will you share the results of your research with policy makers and people working in the financial sector?
This question is important and relates to the dissemination of research. Papers are usually presented at international conferences where academics from universities or schools present the results of their research. Today, in many academic conferences, many “practitioners” also present their research and this research is sometimes even more “academic” than that of the academics! There are also many conferences and seminars organized by international organizations such as the Central Banks (ECB,FeD), the Bank for International Settlements (BIS), the IMF or the regulators (Basel Committee – BCBS) that allow academic and practitioners to share their work and their reflections. Finally, our research work will all be referenced on our website and team members will continue to communicate and explain their work in professional journals and media.
Visit the iℚuant website for more information: https://IℚUANT.IÉSEG.fr
