The Future of Financial Engineering
23 Pages Posted: 3 May 2013 Last revised: 7 Nov 2017
Date Written: May 1, 2013
Convergence of financial theory and practice heralded by the seminal and fundamental economic research by Arrow and Debreu in the early 1950’s has led in the hands of financial engineers to an extraordinary financial innovation in the 70’s and ever since. The theoretical ability to price future assets has led to an explosive growth of financial trading, liquidity and to the growth of finance and its citadels. Options and credit derivative markets, securitization of non or partially liquid assets have provided extraordinary opportunities to “unearth” frozen assets for trade and profit.
The 2007-2009 financial crisis has evoked a greater awareness that traditional financial dogma is based on assumptions that have become increasingly difficult to justify. Globalization, the growth of "Too Big To Fail" (TBTF) firms, insiders trading, information and power asymmetries and the growth of regulation have, among other factors, conspired to render the assumption of complete markets to be unsustainable. Deviant behaviors in financial markets, non-transparency of transactions, complexity and dependence on a global scale have created a fragile and contagious global economy, where systemic risks are no longer an exception but a permanent threat.
By the same token, the explosive growth of information and data fueled by the internet and social media as well as an IT has created far greater dependence of financial systems and institutions on Information Technology (IT) emphasizing information as assets they seek to use for both financial management and competitive advantage. Technology, engineering and financial trends and developments have combined to yield an extraordinary growth of complexity, regulation and globalization, providing new opportunities and risks and undermine the traditional model based approaches to finance.
The purposes of this paper are to outline a number of factors, economic or otherwise that undermine the finance’s fundamental theories, their practice, regulation and their implications to the future of finance. In particular, we emphasize a strategic and multi-polar finance, beset by complexity, chaos and countervailing forces leading a multi-agent finance, computational and financial data-analytics driven rather than simple risk models of uncertainty.
A number of pricing models based on a strategic finance and a micro-matching of economic and financial states are also summarized and their practical implications drawn. In addition, topics such as Big Data finance and multi-agent financial modeling are outlined to provide elements for future theoretical and practical developments. This paper is a work in progress and therefore its intent is to attract greater attention to some elements (however selective and partial) that would contribute to potential transformations of a financial engineering future.
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