FAQs in Quantitative Finance.pdf
FrequentlyAsked Questions 1. What are the different types of Mathematics found in Quantitative Finance? 20 2. What is arbitrage? 25 3. What is put-call parity? 28 4. What is the central limit theorem and what are its implications for finance? 31 5. How is risk defined in mathematical terms? 36 6. What is value at risk and how is it used? 40 7. What is CrashMetrics? 44 8. What is a coherent risk measure and what are its properties? 48 9. What is Modern Portfolio Theory? 51 10. What is the Capital Asset Pricing Model? 54 11. What is Arbitrage Pricing Theory? 58 12. What is Maximum Likelihood Estimation? 61 13. What is cointegration? 67 14. What is the Kelly criterion? 70 15. Why Hedge? 73 16. What is marketing to market and how does it affect risk management in derivatives trading? 79 17. What is the Efficient Markets Hypothesis? 83 x FREQUENTLY ASKED QUESTIONS 18. What are the most useful performance measures? 87 19. What is a utility function and how is it used? 90 20. What is Brownian Motion and what are its uses in finance? 94 21. What is Jensen’s Inequality and what is its role in finance? 97 22. What is Itô’s lemma? 100 23. Why does risk-neutral valuation work? 103 24. What is Girsanov’s theorem and why is it important in finance? 107 25. What are the ‘greeks’? 110 26. Why do quants like closed-form solutions? 116 27. What are the forward and backward equations? 119 28. Which numerical method should I use and when? 123 29. What is Monte Carlo Simulation? 132 30. What is the finite-difference method? 136 31. What is a jump-diffusion model and how does it affect option values? 142 32. What is meant by ‘complete’ and ‘incomplete’ markets? 146 33. What is volatility? 151 34. What is the volatility smile? 157 35. What is GARCH? 164 36. How do I dynamically hedge? 170 37. What is dispersion trading? 176 FREQUENTLY ASKED QUESTIONS xi 38. What is bootstrapping using discount factors? 179 39. What is the LIBOR Market Model and its principle applications in finance? 183 40. What is meant by the ‘value’ of a contract? 188 41. What is calibration? 191 42. What is the market price of risk? 194 43. What is the difference between the equilibrium approach and the no-arbitrage approach to modelling? 198 44. How good is the assumption of normal distributions for financial returns? 201 45. How robust is the Black–Scholes model? 206 46. Why is the lognormal distribution important? 209 47. What are copulas and how are they used in quantitative finance? 212 48. What is the asymptotic analysis and how is it used in financial modelling? 216 49. What is a free-boundary problem and what is the optimal-stopping time for an American option? 220 50. What are low discrepancy numbers? 225
