Financial engineering is a multidisciplinary field involving
financial theory
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 fi ...
, methods of
engineering
Engineering is the use of scientific method, scientific principles to design and build machines, structures, and other items, including bridges, tunnels, roads, vehicles, and buildings. The discipline of engineering encompasses a broad rang ...
, tools of
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 ...
and the practice of
programming.
It has also been defined as the application of technical methods, especially from
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
computational finance
Computational finance is a branch of applied computer science that deals with problems of practical interest in finance.Rüdiger U. Seydel, '' tp://nozdr.ru/biblio/kolxo3/F/FN/Seydel%20R.U.%20Tools%20for%20Computational%20Finance%20(4ed.,%20Spring ...
, in the practice of
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 ...
.
[Tanya S. Beder and Cara M. Marshall, ''Financial Engineering: The Evolution of a Profession'', Wiley (June 7, 2011) 978-0470455814]
Financial engineering plays a key role in the
customer-driven derivatives business
— delivering bespoke
OTC-contracts and
"exotics", and implementing various
structured products —
which encompasses quantitative modelling, quantitative programming and
risk managing financial products in compliance with the regulations and
Basel
, french: link=no, Bâlois(e), it, Basilese
, neighboring_municipalities= Allschwil (BL), Hégenheim (FR-68), Binningen (BL), Birsfelden (BL), Bottmingen (BL), Huningue (FR-68), Münchenstein (BL), Muttenz (BL), Reinach (BL), Riehen (BS ...
capital/liquidity requirements.
An older use of the term "financial engineering" that is less common today is aggressive restructuring of corporate
balance sheet
In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...
s.
Mathematical finance is the application of
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 ...
to finance.
Computational finance and mathematical finance are both subfields of financial engineering. Computational finance is a field in computer science and deals with the data and algorithms that arise in financial modeling.
Discipline
Financial engineering draws on tools from
applied mathematics
Applied mathematics is the application of mathematical methods by different fields such as physics, engineering, medicine, biology, finance, business, computer science, and industry. Thus, applied mathematics is a combination of mathematical s ...
,
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 ...
,
statistics
Statistics (from German language, German: ''wikt:Statistik#German, Statistik'', "description of a State (polity), state, a country") is the discipline that concerns the collection, organization, analysis, interpretation, and presentation of ...
and
economic theory
Economics () is the social science that studies the production, distribution, and consumption of goods and services.
Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics analyzes ...
.
In the broadest sense, anyone who uses technical tools in finance could be called a financial engineer, for example any
computer programmer
A computer programmer, sometimes referred to as a software developer, a software engineer, a programmer or a coder, is a person who creates computer programs — often for larger computer software.
A programmer is someone who writes/creates ...
in a
bank
A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets.
Because ...
or any
statistician
A statistician is a person who works with theoretical or applied statistics. The profession exists in both the private and public sectors.
It is common to combine statistical knowledge with expertise in other subjects, and statisticians may wor ...
in a government economic bureau. However, most practitioners restrict the term to someone educated in the full range of tools of modern finance and whose work is informed by financial theory.
[Salih N. Neftci, ''Principles of Financial Engineering'', Academic Press (December 15, 2008) 978-0123735744] It is sometimes restricted even further, to cover only those originating new financial products and strategies.
[Robert Dubil, ''Financial Engineering and Arbitrage in the Financial Markets'', Wiley (October 11, 2011) 978-0470746011]
Despite its name, financial engineering does not belong to any of the
fields
Fields may refer to:
Music
*Fields (band), an indie rock band formed in 2006
*Fields (progressive rock band), a progressive rock band formed in 1971
* ''Fields'' (album), an LP by Swedish-based indie rock band Junip (2010)
* "Fields", a song by ...
in traditional professional engineering even though many financial engineers have studied engineering beforehand and many universities offering a postgraduate degree in this field require applicants to have a background in engineering as well. In the United States, the
Accreditation Board for Engineering and Technology (ABET) does not accredit financial engineering degrees. In the United States, financial engineering programs are accredited by the ''International Association of Quantitative Finance''.
Quantitative analyst
Quantitative may refer to:
* Quantitative research, scientific investigation of quantitative properties
* Quantitative analysis (disambiguation)
* Quantitative verse, a metrical system in poetry
* Statistics, also known as quantitative analysis
...
("Quant") is a broad term that covers any person who uses math for practical purposes, including financial engineers. Quant is often taken to mean "financial quant", in which case it is similar to financial engineer.
[Espen Gaarder Haug, ''Derivatives Models on Models'', Wiley (July 24, 2007) 978-0470013229] The difference is that it is possible to be a theoretical quant, or a quant in only one specialized niche in finance, while "financial engineer" usually implies a practitioner with broad expertise.
[Richard R. Lindsey and Barry Schachter (editors), ''How I Became a Quant: Insights from 25 of Wall Street's Elite'', Wiley (August 3, 2009) 978-0470452578]
"
Rocket scientist
Aerospace engineering is the primary field of engineering concerned with the development of aircraft and spacecraft. It has two major and overlapping branches: aeronautical engineering and astronautical engineering. Avionics engineering is s ...
" (
aerospace engineer
Aerospace engineering is the primary field of engineering concerned with the development of aircraft and spacecraft. It has two major and overlapping branches: aeronautical engineering and astronautical engineering. Avionics engineering is si ...
) is an older term, first coined in the development of rockets in WWII (
Wernher von Braun
Wernher Magnus Maximilian Freiherr von Braun ( , ; 23 March 191216 June 1977) was a German and American aerospace engineer and space architect. He was a member of the Nazi Party and Allgemeine SS, as well as the leading figure in the develop ...
), and later, the
NASA
The National Aeronautics and Space Administration (NASA ) is an independent agency of the US federal government responsible for the civil space program, aeronautics research, and space research.
NASA was established in 1958, succeeding t ...
space program; it was adapted by the first generation of financial quants who 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 ...
in the late 1970s and early 1980s.
[Emanuel Derman, ''My Life as a Quant: Reflections on Physics and Finance'', Wiley (September 16, 2004) 978-0471394204] While basically synonymous with financial engineer, it implies adventurousness and fondness for
disruptive innovation
In business theory, disruptive innovation is innovation that creates a new market and value network or enters at the bottom of an existing market and eventually displaces established market-leading firms, products, and alliances. The concept was ...
.
[Aaron Brown, ''Red-Blooded Risk: The Secret History of Wall Street'', Wiley (October 11, 2011) 978-1118043868] Financial "rocket scientists" were usually trained in applied mathematics,
statistics
Statistics (from German language, German: ''wikt:Statistik#German, Statistik'', "description of a State (polity), state, a country") is the discipline that concerns the collection, organization, analysis, interpretation, and presentation of ...
or finance and spent their entire careers in risk-taking.
[Aaron Brown, ''The Poker Face of Wall Street'', Wiley (March 31, 2006) 978-0470127315] They were not hired for their mathematical talents, they either worked for themselves or applied mathematical techniques to traditional financial jobs.
The later generation of financial engineers were more likely to have PhDs in mathematics,
physics
Physics is the natural science that studies matter, its fundamental constituents, its motion and behavior through space and time, and the related entities of energy and force. "Physical science is that department of knowledge which r ...
, electrical and computer engineering, and often started their careers in academics or non-financial fields.
[Dan Stefanica, ''A Primer for the Mathematics of Financial Engineering'', FE Press (April 4, 2008) 978-0979757600]
Criticisms
One of the prominent critics of financial engineering is
Nassim Taleb
Nassim Nicholas Taleb (; alternatively ''Nessim ''or'' Nissim''; born 12 September 1960) is a Lebanese-American essayist, mathematical statistician, former option trader, risk analyst, and aphorist whose work concerns problems of randomness, ...
, a professor of financial engineering at
Polytechnic Institute of New York University
The New York University Tandon School of Engineering (commonly referred to as Tandon) is the engineering and applied sciences school of New York University. Tandon is the second oldest private engineering and technology school in the United Sta ...
[Nassim Nicholas Taleb, ''The Black Swan: The Impact of the Highly Improbable'', Random House (April 17, 2007) 978-1400063512] who argues that it replaces common sense and leads to disaster. A series of economic collapses has led many governments to argue a return to "real"
engineering
Engineering is the use of scientific method, scientific principles to design and build machines, structures, and other items, including bridges, tunnels, roads, vehicles, and buildings. The discipline of engineering encompasses a broad rang ...
from financial engineering.
A gentler criticism came from
Emanuel Derman
Emanuel Derman (born 1945) is a South African-born academic, businessman and writer. He is best known as a quantitative analyst, and author of the book ''My Life as a Quant: Reflections on Physics and Finance''.
He is a co-author of Black–Derm ...
[Emanuel Derman, ''Models.Behaving.Badly.: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life'', Free Press (July 24, 2012) 978-1439164990] who heads a financial engineering degree program at Columbia University. He blames over-reliance on models for financial problems; see
Financial Modelers' Manifesto The Financial Modelers' Manifesto was a proposal for more responsibility in risk management and quantitative finance written by financial engineers Emanuel Derman and Paul Wilmott. The manifesto includes a Modelers' Hippocratic Oath. The structur ...
.
Many other authors have identified specific problems in financial engineering that caused catastrophes:
*
Aaron Brown named confusion between quants and regulators over the meaning of "capital"
*
Felix Salmon
Felix Salmon (born 1972) is a financial journalist, formerly of ''Portfolio Magazine'' and ''Euromoney'' and a former finance blogger for Reuters, where he analyzed economic and occasionally social issues in addition to financial commentary. In Apr ...
gently pointed to the
Gaussian copula
In probability theory and statistics, a copula is a multivariate cumulative distribution function for which the marginal probability distribution of each variable is uniform on the interval , 1 Copulas are used to describe/model the de ...
(see )
*
Ian Stewart criticized the
Black-Scholes formula
*Pablo Triana
[< Pablo Triana, The Number That Killed Us: A Story of Modern Banking, Flawed Mathematics, and a Big Financial Crisis '', Wiley (December 6, 2011) 978-0470529737] (
along with others including Taleb and Brown) dislikes
value at risk
Value at risk (VaR) is a measure of the risk of loss for investments. It estimates how much a set of investments might lose (with a given probability), given normal market conditions, in a set time period such as a day. VaR is typically used by ...
*
Scott Patterson
Scott Gordon Patterson (born September 11, 1958) is an American actor and musician. He is known for his role as Luke Danes in ''Gilmore Girls'' and as Special Agent Peter Strahm in the ''Saw'' films. He also starred as Michael Buchanan in the ...
[< Scott Patterson, ''The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It'', Crown Business (February 2, 2010) 978-0307453372][< Scott Patterson, '' Dark Pools: High-Speed Traders, A.I. Bandits, and the Threat to the Global Financial System'', Crown Business (June 12, 2012) 978-0307887177] accused quantitative traders and later high-frequency traders.
The
financial innovation
Financial innovation is the act of creating new financial instruments as well as new financial technologies, institutions, and markets. Recent financial innovations include hedge funds, private equity, weather derivatives, retail-structured pro ...
often associated with financial engineers was mocked by former chairman of the Federal Reserve
Paul Volcker
Paul Adolph Volcker Jr. (September 5, 1927 – December 8, 2019) was an American economist who served as the 12th chairman of the Federal Reserve from 1979 to 1987. During his tenure as chairman, Volcker was widely credited with having ended the ...
in 2009 when he said it was a code word for risky securities, that brought no benefits to society. For most people, he said, the advent of the
ATM was more crucial than any
asset-backed bond.
Education
The first
Master of Financial Engineering
Master or masters may refer to:
Ranks or titles
* Ascended master, a term used in the Theosophical religious tradition to refer to spiritually enlightened beings who in past incarnations were ordinary humans
* Grandmaster (chess), National Maste ...
degree programs were set up in the early 1990s.
The number and size of programs has grown rapidly, to the extent that some now use the term "financial engineer" to refer to a graduate in the field.
The financial engineering program at
New York University Polytechnic School of Engineering
The New York University Tandon School of Engineering (commonly referred to as Tandon) is the engineering and applied sciences school of New York University. Tandon is the second oldest private engineering and technology school in the United Sta ...
was the first curriculum to be certified by the
International Association of Financial Engineers
The International Association for Quantitative Finance (IAQF), formerly the International Association of Financial Engineers (IAFE), is a non-profit professional society dedicated to fostering the fields of quantitative finance and financial engin ...
.
The number, and variation, of these programs has grown over the decades subsequent (see ); and lately includes undergraduate study, as well as
designations such as the
Certificate in Quantitative Finance
Following is a partial list of professional certifications in financial services, with an overview of the educational and continuing requirements for each;
see and :Professional certification in finance for all articles.
As the field of finan ...
.
See also
*
Actuarial science
*
Computational finance
Computational finance is a branch of applied computer science that deals with problems of practical interest in finance.Rüdiger U. Seydel, '' tp://nozdr.ru/biblio/kolxo3/F/FN/Seydel%20R.U.%20Tools%20for%20Computational%20Finance%20(4ed.,%20Spring ...
*
Financial modeling
Financial modeling is the task of building an abstract representation (a model) of a real world financial situation. This is a mathematical model designed to represent (a simplified version of) the performance of a financial asset or portfolio o ...
*
List of finance topics
The following outline is provided as an overview of and topical guide to finance:
Finance – addresses the ways in which individuals and organizations raise and allocate monetary resources over time, taking into account the risks entailed in ...
*
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 ...
*
Quantitative analyst
Quantitative may refer to:
* Quantitative research, scientific investigation of quantitative properties
* Quantitative analysis (disambiguation)
* Quantitative verse, a metrical system in poetry
* Statistics, also known as quantitative analysis
...
*
QuantLib
References
Further reading
*
{{Authority control
Mathematical finance
Engineering disciplines