Section: Overall Objectives

Introduction

MathRisk is a joint Inria project-team with ENPC (CERMICS Laboratory) and the University Paris Est Marne-la-Vallée (UPEMLV, LAMA Laboratory), located in Rocquencourt and Marne-la-Vallée. https://www-rocq.inria.fr/mathfi/ . This project is based on the former Mathfi project team.

Mathfi was founded in 2000, and was devoted to financial mathematics. The project was focused on advanced stochastic analysis and numerical techniques motivated by the development of increasingly complex financial products. Main applications concerned evaluation and hedging of derivative products, dynamic portfolio optimization in incomplete markets, and calibration of financial models. Special attention was paid to models with jumps, stochastic volatility models, asymmetry of information.

Crisis, deregulation, and impact on the research in finance.

The starting point of the development of modern finance theory is traditionally associated to the publication of the famous paper of Black and Scholes in 1973 [66] . Since then, in spite of sporadic crises, generally well overcome, financial markets have grown in a exponential manner. More and more complex exotic derivative products have appeared, on equities first, then on interest rates, and more recently on credit markets. The period between the end of the eighties and the crisis of 2008 can be qualified as the “golden age of financial mathematics”: finance became a quantitative industry, and financial mathematics programs flourished in top universities, involving seminal interplays between the worlds of finance and applied mathematics. During its 12 years existence, the Mathfi project team has extensively contributed to the development of modeling and computational methods for the pricing and hedging of increasingly complex financial products.

Since the crisis of 2008, there has been a critical reorientation of research priorities in quantitative finance with emphasis on risk. In 2008, the “subprime” crisis has questioned the very existence of some derivative products such as CDS (credit default swaps) or CDOs (collateralized debt obligations), which were accused to be responsible for the crisis. The nature of this crisis is profoundly different from the previous ones. It has negatively impacted the activity on the exotic products in general, - even on equity derivative markets-, and the interest in the modeling issues for these products. The perfect replication paradigm, at the origin of the success of the Black and Scholes model became unsound, in particular through the effects of the lack of liquidity. The interest of quantitative finance analysts and mathematicians shifted then to more realistic models taking into account the multidimensional feature and the incompleteness of the markets, but as such getting away from the “lost paradi(gm)” of perfect replication. These models are much more demanding numerically, and require the development of hedging risk measures, and decision procedures taking into account the illiquidity and various defaults.

Moreover, this crisis, and in particular the Lehman Brothers bankruptcy and its consequences, has underlined a systemic risk due to the strong interdependencies of financial institutions. The failure of one of them can cause a cascade of failures, thus affecting the global stability of the system. Better understanding of these interlinkage phenomena becomes crucial.

At the same time, independently from the subprime crisis, another phenomenon has appeared: deregulation in the organization of stock markets themselves. This has been encouraged by the Markets in Financial Instruments Directive (MIFID) which is effective since November, 1st 2007. This, together with the progress of the networks, and the fact that all the computers have now a high computation power, have induced arbitrage opportunities on the markets, by very short term trading, often performed by automatic trading. Using these high frequency trading possibilities, some speculating operators benefit from the large volatility of the markets. For example, the flash crash of May, 6 2010 has exhibited some perverse effects of these automatic speculating trading strategies. These phenomena are not well understood and the theme of high frequency trading needs to be explored.

To summarize, financial mathematics is facing the following new evolutions:

• the complete market modeling has become unsatisfactory to provide a realistic picture of the market and is replaced by incomplete and multidimensional models which lead to new modeling and numerical challenges.

• quantitative measures of risk coming from the markets, the hedging procedures, and the lack of liquidity are crucial for banks,

• uncontrolled systemic risks may cause planetary economic disasters, and require better understanding,

• deregulation of stock markets and its consequences lead to study high frequency trading.

The new project team MathRisk is designed to address these new issues, in particular dependence modeling, systemic risk, market microstructure modeling and risk measures. The research in modeling and numerical analysis remain active in this new context, motivated by new issues.

The MathRisk project team develops the software Premia dedicated to pricing and hedging options and calibration of financial models, in collaboration with a consortium of financial institutions. https://www-rocq.inria.fr/mathfi/Premia/ .

The MathRisk project is part of the Université Paris-Est “Labex” BÉZOUT.