Welcome
This website is the homepage for the Financial Engineering project for SYS and OR 699 for Fall of 2013.
Many
scientists have devoted study to the credit crisis which started in
2007 and have in turn asked, "Could this have been predicted?"
Analytically, this would be difficult--dynamics of realistic
interactions between a large population of economic agents are far too
complicated to compute analytically. However, where traditional
economic analysis falls short, it is possible that agent-based modeling
(ABM) can provide some insight due to the ability to model interactions
between agents and therefore how an economic system changes over time
due to these agent-to-agent interactions. Specifically, the
purpose of this project is to evaluate whether or not ABM can be used to
successfully model a financial system and study the dynamic properties
of interactions and their connection to potential financial crisis.
ABM
shall be used as the main tool for studying and predicting the
emergence of risk events associated with a failed (total collapse and
liquidation) hedge fund. The rationale for scoping the study using
a failed hedge fund is three-fold. First, modeling the global
economy is infeasible due to the size of the global economy (would
require potentially millions of specialized agents) and would require
in-depth knowledge of mathematics, sociology, and psychology--modeling a
hedge fund and its associated entities is achievable given the timeline
of the study. Second, as hedge funds have more relaxed regulatory
requirements than mutual funds, they can engage in more risky trading
behavior, exposing themselves to potentially more chances of making
investments which lose value--in turn causing a "financial crisis" for
the hedge fund and its associated entities. Third, there are many
examples in the history of the financial market of failed hedge funds to
calibrate an agent-based model against. One such failed hedge
fund is Long Term Capital Management (LTCM).
Although
it is uncertain whether the ABM model will produce results similar
(i.e. the model may show that the modeled hedge funds' overall portfolio
value has decreased similarly to crash levels) to that of the LTCM
crash in 1998, the ABM model could have important potential to study
general financial failure for hedge funds. Financial failure is
defined by extreme portfolio value loss when capital lost exceeds
capital required to cover losses. VaR traditionally computes a
probability of when a certain capital requirement level is not exceeded
within a set number of business days. The complement of that event
is the probability of failure that will be compared against the failure
rate derived from the ABM model. If the ABM model clearly
demonstrates a higher likelihood of extreme events to include heavy
portfolio loss for a LTCM-like hedge fund when compared to traditional
approaches such as VaR, the proposed ABM model can become a baseline in
the future for other hedge funds with their own distinct trading
strategies and inherent risks.