Finance, risk and economic space

Olkhov, Victor (2016): Finance, risk and economic space. Published in: ACRN Oxford Journal of Finance and Risk Perspectives , Vol. 5, No. 1 (March 2016): pp. 209-221.

Abstract

This paper presents new approach to financial modeling and forecasting that is based on economic space notion. Economic space is defined as generalization of risk ratings and allows boost methods and description of financial processes. Risk ratings of economic agents are treated as coordinates of economic agents on economic space. Economic and financial variables of separate economic agents determine macroeconomic and financial variables as functions of time and coordinates on economic space. That permits describe financial relations similar to mathematical physics equations. Financial models can be described on discreet and continuous economic spaces with dimension determined by number of major risks measured simultaneously. To show advantages of economic space usage to financial modeling we present extension of Black-Scholes-Merton equation on n-dimensional economic space; develop macroeconomic models on economic space in a way similar to hydrodynamics and derive financial wave equations.

• Item Type: MPRA Paper
• Language: English
• Keywords: risk ratings, economic space, option pricing, financial wave equations
• Subjects: C - Mathematical and Quantitative Methods > C0 - General > C02 - Mathematical Methods; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E17 - Forecasting and Simulation: Models and Applications; G - Financial Economics > G1 - General Financial Markets

References

Asada, T., & Ishikawa, T. (2007). Time and Space in Economics. Springer Japan.

BIS. (2011).Range of Methodologies for Risk and Performance Alignment of Remuneration. Bank for International Settlements. http://www.bis.org/publ/bcbs194.pdf

BIS. (2014). Foundations of the standardized approach for measuring counterparty credit risk exposure. Bank for International Settlements. http://www.bis.org/publ/bcbs279.pdf

Black, F., & Scholes, M. (1973). The pricing of options and corporate liabilities. Journal of Political Economy, 81, 637–659.

DBRS. (2015). Industry Study, 2014 DBRS Structured Finance Rating Transition and Default. http://www.dbrs.com/research/278498/2014-dbrs-structured-finance-rating-transition-and-defaultstudy.pdf.

Fitch. (2010). Structured Finance. Global Rating Criteria for Structured Finance CDOs. https://www.fitchratings.co.jp/ja/images/RC_20101015_Global%20Rtg%20Criteria%20for%20SF%20 CDOs_EN.pdf.

Fujita, M. (2010). The Evolution Of Spatial Economics: From Thünen To The New Economic Geography. The Japanese Economic Review 61, 1-32.

Hull, J.C. (2009). Options, Futures and other Derivatives. (7th.ed., pp. 287-288), Pearson Prentice Hall, New Jersey, USA.

Judd, K., & Tesfatsion, L.,(Eds). (2005). Handbook of Computational Economics, Vol. 2: Agent-Based Computational Economics, Elsevier, North-Holland.

Landau, L.D., & Lifshitz, E.M. (1981). Physical Kinetics. Pergamon Press Ltd., NY.

Landau, L.D., & Lifshitz, E.M. (1987). Fluid Mechanics. Pergamon Press Ltd., NY.

Merton, R. (1973). Theory of Rational Option Pricing. The Bell J. of Economic and Management Sci., 4, (1), 141-183.

Merton, R. (1998). Application of Option Pricing Theory: Twenty Five Years Later. The American Economic Review, 88, (3), 323-349.

Moody’s. (2007). Introducing Moody's Credit Transition Model. 1-26, http://www.moodysanalytics.com/~/media/Brochures/Credit-Research-Risk-Measurement/Quantative- Insight/Credit-Transition-Model/Introductory-Article-Credit-Transition-Model.pdf .

Perroux, F. (1950). Economic Space: Theory and Applications. The Quarterly Journal of Economics, 64, 89-104.

S&P. (2012). Default, Transition, and Recovery: 2011 Annual U.S. Corporate Default Study And Rating Transitions., S&P. http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2012-03- 23_2011AnnualUSCorpDefaultStudy.pdf .