Chapter 14. Financial Engineering

I’ve got the brains, you’ve got the looks Let’s make lots of money You’ve got the brawn, I’ve got the brains Let’s make lots of money

Pet Shop Boys, “Opportunities (Let’s Make Lots of Money)”

14.0 Introduction

Financial engineering (also known as computational finance) is the use of computers to create mathematical models and simulations that attempt to price financial instruments, model their sensitivity to changes in the market, hedge against these changes, and measure and manage risk. This is a high-stakes game, where there can be great reward for getting things right but even greater loss if you get things wrong. This became acutely evident during the financial crisis that started around July 2007. It might be tempting to conclude that attempts to bring mathematical rigor to the chaos of the market is foolhardy, but this would be like concluding that traditional engineering is foolhardy because a plane crashed or a bridge fell. Such failings are human failings, not mathematical ones. They only point to the need to use computational tools more diligently and more responsibly.

One goal for this chapter was to create a variety of recipes with a range of difficulties. This means that there are some recipes that may seem trivial and others that a novice might find difficult. Almost every recipe tries to demonstrate techniques that are unique to Mathematica; I hope readers of every skill level will take away techniques that they can apply to financial ...

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