What is Financial Engineering?

A financial engineer is someone who uses computer programming, finance, and mathematics to analyze financial assets. Many financial engineers specialize in specific areas of finance such as trading, risk management, asset management, and corporate finance. Some popular positions are algorithmic trader, derivatives trader, strategist, finance software engineer, proprietary trader, hedge fund managers, and risk manager. Risk management is a very broad area which could be a job for an investment bank, hedge fund, or any financial or corporate institutions who is looking to manage their risk in financial assets.

Financial engineering is relatively new and the father of financial engineering is Fischer Black. There are about 22 master programs in North America and data about these programs and rankings can be found on QuantNet.com. The field has been controversial in the news lately since most derivatives are created or transacted by financial engineers.

For anyone who is interested in learning more about the field I would recommend reading two books. The most influential book I have ever read is a book about Fischer Black called Fischer Black and the Revolutionary Idea of Finance. Fischer Black based his life on the CAPM model and the pursuit for knowledge. Financial engineering is all about creating new models and theories which can be seen in Fischer Black's life. If you are considering financial engineering and don’t eat, sleep, and dream about finance I would not recommend pursuing it. The average salary is fairly high and the growth potential is good but only for those who are dedicated.

The second book is My Life as a Quant by Emanuel Derman. The book is about Emanuel Derman’s life and how he became a quant. He like many financial engineers that helped start the field were from quantitative fields such as physics. He now teaches at Columbia University and has contributed to the field in many ways as a professor and practitioner.

The road to becoming a financial engineer is long and hard. A master is a minimum requirement for quant positions at investment banks and other financial institutions. The programs are getting more competitive every year as students from around the world are competing to become financial engineers. There are also more programs being created to meet the high demand for financial engineers but be wary since where you go matters just as much as what you know and who you know.

Please feel free to leave comments or ask questions.

Irrational Financial Advisors

     An interesting approach that I have never thought about is the CAPM (capital asset pricing model) with a lifetime of investing. Typical financial advisors will tell you to load up on risk when you are young and then ease off of it as you get older. One might think this makes sense but it is a mirage. The concept that when you are young you expect to have more time and could make up a loss if one was taken. The question is why you would take that risk if no additional return is granted. According to the CAPM which is widely accepted, diversification of risky assets reduces unsystematic risk (the risk which an individual stock contains that can be diversified away. In contrast is systematic risk which is also called market risk and cannot be diversified away). So why should an investor stock up on risky assets such as stocks at a young age and bear more risk than is preferred? It would make more sense to develop a well balanced portfolio of stocks and bonds and hold a portfolio that matches ones risk preferences. An individual’s risk preferences might change over one's life but betting that markets will be positive long enough for you to recoup your losses is irrational. Investors, especially average people should not take bets that they do not understand. A market can crash at anytime and as Maynard Keynes once said, "Markets can remain irrational longer than you can remain solvent." Don't be fooled by high end investment banks.

Fischer Black

The inspiration for this article is based on the thoughts of Fischer Black. For those of you who don't know who Fischer is, he is the father of financial engineering and one of the brightest minds the world will see. He was many generations ahead of his time in the thoughts he produced. He is still very controversial due to his forward thinking. He is also the only person I know that believes as I do in a general equilibrium. I hope that this article makes you think twice about your investing practices.