Computational finance is a branch of applied

computer science Computer science is the study of computation, automation, and information. Computer science spans theoretical disciplines (such as algorithms, theory of computation, information theory, and automation) to Applied science, practical discipli ...

that deals with problems of practical interest in

finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fina ...

.Rüdiger U. Seydel, '' tp://nozdr.ru/biblio/kolxo3/F/FN/Seydel%20R.U.%20Tools%20for%20Computational%20Finance%20(4ed.,%20Springer,%202009)(ISBN%203540929282)(O)(348s)_FN_.pdf Tools for Computational Finance', Springer; 3rd edition (May 11, 2006) 978-3540279235 Some slightly different definitions are the study of

data In the pursuit of knowledge, data (; ) is a collection of discrete values that convey information, describing quantity, quality, fact, statistics, other basic units of meaning, or simply sequences of symbols that may be further interpreted ...

and

algorithm In mathematics and computer science, an algorithm () is a finite sequence of rigorous instructions, typically used to solve a class of specific Computational problem, problems or to perform a computation. Algorithms are used as specificat ...

s currently used in finance and the

mathematics Mathematics is an area of knowledge that includes the topics of numbers, formulas and related structures, shapes and the spaces in which they are contained, and quantities and their changes. These topics are represented in modern mathematics ...

computer program A computer program is a sequence or set of instructions in a programming language for a computer to execute. Computer programs are one component of software, which also includes documentation and other intangible components. A computer program ...

s that realize financial

models A model is an informative representation of an object, person or system. The term originally denoted the plans of a building in late 16th-century English, and derived via French and Italian ultimately from Latin ''modulus'', a measure. Models c ...

system A system is a group of Interaction, interacting or interrelated elements that act according to a set of rules to form a unified whole. A system, surrounded and influenced by its environment (systems), environment, is described by its boundaries, ...

s.Cornelis A. Los, ''Computational Finance'' World Scientific Pub Co Inc (December 2000) Computational finance emphasizes practical

numerical methods Numerical analysis is the study of algorithms that use numerical approximation (as opposed to symbolic manipulations) for the problems of mathematical analysis (as distinguished from discrete mathematics). It is the study of numerical methods th ...

rather than

mathematical proof A mathematical proof is an inferential argument for a mathematical statement, showing that the stated assumptions logically guarantee the conclusion. The argument may use other previously established statements, such as theorems; but every proo ...

s and focuses on techniques that apply directly to economic analyses.Mario J. Miranda and Paul L. Fackler, ''Applied Computational Economics and Finance'', The MIT Press (September 16, 2002) It is an interdisciplinary field between

mathematical finance Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling of financial markets. In general, there exist two separate branches of finance that require ...

and

.Omur Ugur, ''Introduction to Computational Finance'', Imperial College Press (December 22, 2008) Two major areas are efficient and accurate computation of

fair value In accounting and in most schools of economic thought, fair value is a rational and unbiased estimate of the potential market price of a good, service, or asset. The derivation takes into account such objective factors as the costs associated wi ...

s of

financial securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...

and the modeling of

stochastic Stochastic (, ) refers to the property of being well described by a random probability distribution. Although stochasticity and randomness are distinct in that the former refers to a modeling approach and the latter refers to phenomena themselv ...

time series In mathematics, a time series is a series of data points indexed (or listed or graphed) in time order. Most commonly, a time series is a sequence taken at successive equally spaced points in time. Thus it is a sequence of discrete-time data. Exa ...

.Jin-Chuan Duan, Wolfgang Karl Härdle and James E. Gentle (editors), ''Handbook of Computational Finance'', Springer (October 25, 2011)

History

The birth of computational finance as a discipline can be traced to

Harry Markowitz Harry Max Markowitz (born August 24, 1927) is an American economist who received the 1989 John von Neumann Theory Prize and the 1990 Nobel Memorial Prize in Economic Sciences. Markowitz is a professor of finance at the Rady School of Management ...

in the early 1950s. Markowitz conceived of the portfolio selection problem as an exercise in mean-variance optimization. This required more computer power than was available at the time, so he worked on useful algorithms for approximate solutions.Harry M. Markowitz, ''Portfolio Selection: Efficient Diversification of Investments'', Wiley, second edition (September 3, 1991) 978-1557861085 Mathematical finance began with the same insight, but diverged by making simplifying assumptions to express relations in simple closed forms that did not require sophisticated computer science to evaluate.Justin Fox, ''The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street'', HarperBusiness (June 9, 2009) In the 1960s, hedge fund managers such as

Ed Thorp Edward Oakley Thorp (born August 14, 1932) is an American mathematics professor, author, hedge fund manager, and blackjack researcher. He pioneered the modern applications of probability theory, including the harnessing of very small correlatio ...

William Poundstone, ''Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street'', Hill and Wang (September 19, 2006) and Michael Goodkin (working with Harry Markowitz,

Paul Samuelson Paul Anthony Samuelson (May 15, 1915 – December 13, 2009) was an American economist who was the first American to win the Nobel Memorial Prize in Economic Sciences. When awarding the prize in 1970, the Swedish Royal Academies stated that he "h ...

and

Robert C. Merton Robert Cox Merton (born July 31, 1944) is an American economist, Nobel Memorial Prize in Economic Sciences laureate, and professor at the MIT Sloan School of Management, known for his pioneering contributions to continuous-time finance, especia ...

)Michael Goodkin, ''The Wrong Answer Faster: The Inside Story of Making the Machine that Trades Trillions'', Wiley, (February 21, 2012) pioneered the use of computers in

arbitrage In economics and finance, arbitrage (, ) is the practice of taking advantage of a difference in prices in two or more markets; striking a combination of matching deals to capitalise on the difference, the profit being the difference between the ...

trading. In academics, sophisticated computer processing was needed by researchers such as

Eugene Fama Eugene Francis "Gene" Fama (; born February 14, 1939) is an American economist, best known for his empirical work on portfolio theory, asset pricing, and the efficient-market hypothesis. He is currently Robert R. McCormick Distinguished Servic ...

in order to analyze large amounts of financial data in support of the

efficient-market hypothesis The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted bas ...

. During the 1970s, the main focus of computational finance shifted to

options pricing In finance, a price (premium) is paid or received for purchasing or selling options. This article discusses the calculation of this premium in general. For further detail, see: for discussion of the mathematics; Financial engineering for the impl ...

and analyzing

mortgage A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any pu ...

securitization Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling ...

s.Aaron Brown, ''Red-Blooded Risk: The Secret History of Wall Street'', Wiley (October 11, 2011) In the late 1970s and early 1980s, a group of young quantitative practitioners who became known as "rocket scientists" arrived on

Wall Street Wall Street is an eight-block-long street in the Financial District of Lower Manhattan in New York City. It runs between Broadway in the west to South Street and the East River in the east. The term "Wall Street" has become a metonym for t ...

and brought along

personal computer A personal computer (PC) is a multi-purpose microcomputer whose size, capabilities, and price make it feasible for individual use. Personal computers are intended to be operated directly by an end user, rather than by a computer expert or tec ...

s. This led to an explosion of both the amount and variety of computational finance applications.John F. Ehlers, ''Rocket Science for Traders'', Wiley (July 20, 2001) Many of the new techniques came from

signal processing Signal processing is an electrical engineering subfield that focuses on analyzing, modifying and synthesizing ''signals'', such as audio signal processing, sound, image processing, images, and scientific measurements. Signal processing techniq ...

and

speech recognition Speech recognition is an interdisciplinary subfield of computer science and computational linguistics that develops methodologies and technologies that enable the recognition and translation of spoken language into text by computers with the m ...

rather than traditional fields of

computational economics Computational Economics is an interdisciplinary research discipline that involves computer science, economics, and management science.''Computational Economics''."About This Journal"an"Aims and Scope" This subject encompasses computational model ...

optimization Mathematical optimization (alternatively spelled ''optimisation'') or mathematical programming is the selection of a best element, with regard to some criterion, from some set of available alternatives. It is generally divided into two subfi ...

and

analysis. By the end of the 1980s, the winding down of the

Cold War The Cold War is a term commonly used to refer to a period of geopolitical tension between the United States and the Soviet Union and their respective allies, the Western Bloc and the Eastern Bloc. The term '' cold war'' is used because the ...

brought a large group of displaced

physicist A physicist is a scientist who specializes in the field of physics, which encompasses the interactions of matter and energy at all length and time scales in the physical universe. Physicists generally are interested in the root or ultimate caus ...

s and applied mathematicians, many from behind the

Iron Curtain The Iron Curtain was the political boundary dividing Europe into two separate areas from the end of World War II in 1945 until the end of the Cold War in 1991. The term symbolizes the efforts by the Soviet Union (USSR) to block itself and its s ...

, into finance. These people become known as " financial engineers" ("quant" is a term that includes both rocket scientists and financial engineers, as well as quantitative portfolio managers).Aaron Brown, ''The Poker Face of Wall Street'', Wiley (March 31, 2006) 978-0470127315 This led to a second major extension of the range of computational methods used in finance, also a move away from personal computers to

mainframes A mainframe computer, informally called a mainframe or big iron, is a computer used primarily by large organizations for critical applications like bulk data processing for tasks such as censuses, industry and consumer statistics, enterprise ...

and

supercomputer A supercomputer is a computer with a high level of performance as compared to a general-purpose computer. The performance of a supercomputer is commonly measured in floating-point operations per second ( FLOPS) instead of million instructions ...

s. Around this time computational finance became recognized as a distinct academic subfield. The first degree program in computational finance was offered by

Carnegie Mellon University Carnegie Mellon University (CMU) is a private research university in Pittsburgh, Pennsylvania. One of its predecessors was established in 1900 by Andrew Carnegie as the Carnegie Technical Schools; it became the Carnegie Institute of Technology ...

in 1994. Over the last 20 years, the field of computational finance has expanded into virtually every area of finance, and the demand for practitioners has grown dramatically. Moreover, many specialized companies have grown up to supply computational finance software and services.

Applications of Computational Finance

Algorithmic trading Algorithmic trading is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume. This type of trading attempts to leverage the speed and computational resources of ...

Quantitative investing Quantitative analysis is the use of mathematical and statistical methods in finance and investment management. Those working in the field are quantitative analysts (quants). Quants tend to specialize in specific areas which may include derivative s ...

High-frequency trading High-frequency trading (HFT) is a type of algorithmic financial trading characterized by high speeds, high turnover rates, and high order-to-trade ratios that leverages high-frequency financial data and electronic trading tools. While there is no ...

References

External links

IEEE Computational Finance and Economics Technical CommitteeAn Introduction to Computational Finance without Agonizing PainIntroduction to Computational Finance, IEEE Computational Intelligence Society Newsletter, August 2004Centre for Computational Finance and Economic Agents (CCFEA)The Journal of Computational Finance
{{Finance Mathematical finance Actuarial science Computational fields of study

History

Applications of Computational Finance

See also

References

External links