View source for Financial engineering

{{Short description|Application of mathematical and computational practices in finance}}
{{Financial markets}}
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The main applications of financial engineering<ref name=Capiski>Marek Capiski and Tomasz Zastawniak, ''Mathematics for Finance: An Introduction to Financial Engineering'', Springer (November 25, 2010) 978-0857290816</ref><ref name=Ruppert>David Ruppert, ''Statistics and Data Analysis for Financial Engineering'', Springer (November 17, 2010) 978-1441977861</ref> are to:
* [[Arbitrage]]
* [[Corporate finance]]
* [[derivative (finance)|Derivatives pricing]]
* [[Market maker|Execution]]
* [[Financial regulation]]
* [[Investment management|Portfolio management]]
* [[Risk management]]
* [[Structured product]]s
* International finance and financial administration
* [[Valuation of options]]
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'''Financial engineering''' is a multidisciplinary field involving [[financial theory]], methods of [[engineering]], tools of [[mathematics]] and the practice of [[Mathematical programming|programming]].<ref name="IEOR">{{cite web|url=http://ieor.columbia.edu/ms-financial-engineering|title=MS in Financial Engineering|publisher=Columbia University Department of Industrial Engineering and Operations Research|access-date=2017-01-18|archive-url=https://web.archive.org/web/20170119053357/http://ieor.columbia.edu/ms-financial-engineering|archive-date=2017-01-19|url-status=live}}</ref> It has also been defined as the application of technical methods, especially from [[mathematical finance]] and [[computational finance]], in the practice of [[finance]].<ref name=Beder>Tanya S. Beder and Cara M. Marshall, ''Financial Engineering: The Evolution of a Profession'', Wiley (June 7, 2011) 978-0470455814</ref>

Financial engineering plays a key role in a bank's [[Investment banking#Sales and trading|customer-driven derivatives business]]<ref>Qu, Dong (2016). ''[https://www.amazon.com/gp/product/1118632621?keywords=dong%20qu&qid=1444725736&ref_=sr_1_2&sr=8-2 Manufacturing and Managing Customer-Driven Derivatives]''. Wiley. {{ISBN|978-1-118-63262-8}}.</ref> 
— delivering bespoke [[Over-the-counter (finance)#Contracts|OTC-contracts]] and [[exotic derivative|"exotics"]], and implementing various [[structured products]] — 
which encompasses quantitative modelling, quantitative programming and [[risk management|risk managing]] financial products in compliance with the regulations and [[Basel Accords|Basel]] capital/liquidity requirements.

An older use of the term "financial engineering" that is less common today is aggressive restructuring of corporate [[balance sheet]]s.{{citation needed|date=June 2023}} Computational finance and mathematical finance both overlap with financial engineering.{{citation needed|date=October 2019}} 
Mathematical finance is the application of [[mathematics]] to finance.<ref name="Dubil" /> Computational finance is a field in computer science and deals with the data and algorithms that arise in financial modeling.

==Discipline==
Financial engineering draws on tools from [[applied mathematics]], [[computer science]], [[statistics]] and [[economic theory]].<ref name=IAFE>{{cite web|url=http://www.iafeguide.org/financial-engineer.php|title=What is Financial Engineering?|publisher=International Association of Financial Engineers|access-date=2012-07-22|archive-url=https://web.archive.org/web/20120630202827/http://www.iafeguide.org/financial-engineer.php|archive-date=2012-06-30|url-status=dead}}</ref>
In the broadest sense, anyone who uses technical tools in finance could be called a financial engineer, for example any [[computer programmer]] in a [[bank]] or any [[statistician]] in a government economic bureau.<ref>Ali N. Akansu and Mustafa U. Torun. (2015), A Primer for Financial Engineering: Financial Signal Processing and Electronic Trading, Boston, MA: Academic Press, {{ISBN|978-0-12-801561-2}}</ref> However, most practitioners restrict the term to someone educated in the full range of tools of modern finance and whose work is informed by financial theory.<ref name=Neftci>Salih N. Neftci, ''Principles of Financial Engineering'', Academic Press (December 15, 2008) 978-0123735744</ref> It is sometimes restricted even further, to cover only those originating new financial products and strategies.<ref name=Dubil>Robert Dubil, ''Financial Engineering and Arbitrage in the Financial Markets'', Wiley (October 11, 2011) 978-0470746011</ref>

Despite its name, financial engineering does not belong to any of the [[Fields of engineering|fields]] in traditional professional engineering even though many financial engineers have studied engineering beforehand and many universities offering a postgraduate degree in this field require applicants to have a background in engineering as well.<ref>Entry requirements | Imperial College Business School. 2016. Entry requirements | Imperial College Business School. [ONLINE] Available at: http://wwwf.imperial.ac.uk/business-school/programmes/msc-risk-management/entry-requirements/ {{Webarchive|url=https://web.archive.org/web/20160627201710/http://wwwf.imperial.ac.uk/business-school/programmes/msc-risk-management/entry-requirements/|date=2016-06-27}}. [Accessed 30 June 2016]. Add to My References</ref><ref>{{Cite web|url=https://www.zfuw.uni-kl.de/en/science-engineering/financial-engineering | title=Master Financial Engineering postgraduate distance learning-TU Kaiserslautern}}</ref> In the United States, the [[Accreditation Board for Engineering and Technology]] (ABET) does not accredit financial engineering degrees.<ref>{{cite web|url=http://www.abet.org/member-society-list/|title=List of Member Societies|publisher=[[ABET]]|archive-url=https://web.archive.org/web/20130430203038/http://abet.org/member-society-list/|archive-date=2013-04-30|url-status=live|access-date=26 April 2013}}</ref> In the United States, financial engineering programs are accredited by the ''International Association of Quantitative Finance''.<ref>{{Cite web|url=http://iaqf.org/|title={title}|archive-url=https://web.archive.org/web/20180613172851/https://www.iaqf.org/|archive-date=2018-06-13|url-status=live|access-date=2018-08-21}}</ref>

[[Quantitative analyst]] ("Quant") is a broad term that covers any person who uses math for practical purposes, including financial engineers. Quant is often taken to mean "financial quant", in which case it is similar to financial engineer.<ref name="Haug">Espen Gaarder Haug, ''Derivatives Models on Models'', Wiley (July 24, 2007) 978-0470013229</ref> The difference is that it is possible to be a theoretical quant, or a quant in only one specialized niche in finance, while "financial engineer" usually implies a practitioner with broad expertise.<ref name="Lindsey">Richard R. Lindsey and Barry Schachter (editors), ''How I Became a Quant: Insights from 25 of Wall Street's Elite'', Wiley (August 3, 2009) 978-0470452578</ref>

"[[Rocket scientist]]" ([[aerospace engineer]]) is an older term, first coined in the development of rockets in WWII ([[Wernher von Braun]]), and later, the [[NASA]] space program; it was adapted by the first generation of financial quants who arrived on [[Wall Street]] in the late 1970s and early 1980s.<ref name="Derman">Emanuel Derman, ''My Life as a Quant: Reflections on Physics and Finance'', Wiley (September 16, 2004) 978-0471394204</ref> While basically synonymous with financial engineer, it implies adventurousness and fondness for [[disruptive innovation]].<ref name="Brown">Aaron Brown, ''Red-Blooded Risk: The Secret History of Wall Street'', Wiley (October 11, 2011) 978-1118043868</ref> Financial "rocket scientists" were usually trained in applied mathematics, [[statistics]] or finance and spent their entire careers in risk-taking.<ref name="Brown1">Aaron Brown, ''The Poker Face of Wall Street'', Wiley (March 31, 2006) 978-0470127315</ref> They were not hired for their mathematical talents, they either worked for themselves or applied mathematical techniques to traditional financial jobs.<ref name="Neftci" /><ref name="Brown" /> The later generation of financial engineers were more likely to have PhDs in mathematics, [[physics]], electrical and computer engineering, and often started their careers in academics or non-financial fields.<ref name="Stefanica">Dan Stefanica, ''A Primer for the Mathematics of Financial Engineering'', FE Press (April 4, 2008) 978-0979757600</ref><ref>Akansu, Ali N.; Kulkarni, Sanjeev R.; Malioutov, Dmitry M., Eds. (2016), Financial Signal Processing and Machine Learning, Hoboken, NJ: Wiley-IEEE Press, {{ISBN|978-1-118-74567-0}}</ref>

==Criticisms==
{{See also|Financial mathematics#Criticism|Financial economics#Challenges and criticism}}

One of the prominent critics of financial engineering is [[Nassim Taleb]], a professor of financial engineering at [[Polytechnic Institute of New York University]]<ref name=Taleb>Nassim Nicholas Taleb, ''The Black Swan: The Impact of the Highly Improbable'', Random House (April 17, 2007) 978-1400063512</ref> who argues that it replaces common sense and leads to disaster.  A series of economic collapses has led many governments to argue a return to "real" [[engineering]] from financial engineering.
A gentler criticism came from [[Emanuel Derman]]<ref name=Derman1>Emanuel Derman, ''Models.Behaving.Badly.: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life'', Free Press (July 24, 2012) 978-1439164990</ref> who heads a financial engineering degree program at Columbia University. He blames over-reliance on models for financial problems; see [[Financial Modelers' Manifesto]].

Many other authors have identified specific problems in financial engineering that caused catastrophes: 
*[[Aaron Brown (financial author)|Aaron Brown]]<ref name=Brown2>{{cite web|url=http://www.minyanville.com/business-news/markets/articles/quants-quant-traders-trading-quantitative-traders/7/9/2012/id/42227|title=''Whodunit? Rocket Scientists on Wall Street''|publisher=Minyanville|access-date=2012-07-22|archive-url=https://web.archive.org/web/20120711201635/http://www.minyanville.com/business-news/markets/articles/quants-quant-traders-trading-quantitative-traders/7/9/2012/id/42227|archive-date=2012-07-11|url-status=live}}</ref> named confusion between quants and regulators over the meaning of "capital".
*[[Felix Salmon]]<ref name=Salmon>{{cite news|url=https://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all|title=''Recipe for Disaster: The Formula that Killed Wall Street''|publisher=Wired|access-date=2012-07-22|date=February 23, 2009|archive-url=https://web.archive.org/web/20120726220713/http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all|archive-date=2012-07-26|url-status=live}}</ref> gently pointed to the [[Copula (probability theory)#Quantitative finance|Gaussian copula]] (see {{section link|David X. Li#CDOs and Gaussian copula}}).
*[[Ian Stewart (mathematician)|Ian Stewart]]<ref name=Stewart>{{cite news|url=https://www.theguardian.com/science/2012/feb/12/black-scholes-equation-credit-crunch|title=''The Mathematical Equation that Caused the Banks to Crash''|publisher=Wired|access-date=2012-07-22|location=London|first=Ian|last=Stewart|date=February 12, 2012|archive-url=https://web.archive.org/web/20130927060129/http://www.theguardian.com/science/2012/feb/12/black-scholes-equation-credit-crunch|archive-date=2013-09-27|url-status=live}}</ref> criticized the [[Black-Scholes formula]].
*Pablo Triana<ref name=Triana>< Pablo Triana, The Number That Killed Us: A Story of Modern Banking, Flawed Mathematics, and a Big Financial Crisis '', Wiley (December 6, 2011) 978-0470529737</ref> ([[Value at risk#Criticism|along with others]] including Taleb and Brown) dislikes [[value at risk]].
*[[Scott Patterson (author)|Scott Patterson]]<ref name=Patterson>< Scott Patterson, ''The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It'', Crown Business (February 2, 2010) 978-0307453372</ref><ref name=Patterson1>< Scott Patterson, '' Dark Pools: High-Speed Traders, A.I. Bandits, and the Threat to the Global Financial System'', Crown Business (June 12, 2012) 978-0307887177</ref> accused [[Quantitative analysis (finance)#Quantitative investment management|quantitative traders]] and later [[High-frequency trading|high-frequency traders]].
*[[Douglas W. Hubbard]]<ref>Douglas W. Hubbard. ''The Failure of Risk Management'', p. 67, [[John Wiley & Sons]], 2009. {{ISBN |978-0-470-38795-5}}</ref> notes that the Black–Scholes formula, along with [[modern portfolio theory]], makes no attempt to explain an underlying structure to price changes.
*[[James Rickards]]<ref>[https://web.archive.org/web/20091007063524/http://gop.science.house.gov/Media/hearings/oversight09/sept10/rickards.pdf "Testimony of James G. Rickards, Senior Managing Director for Market Intelligence, Omnis, Inc., McLean, VA"] (PDF) [[U.S. House Committee on Science, Space and Technology]] (September 10, 2009). Retrieved May 16, 2011</ref> posits that the "key assumptions" underpinning [[financial risk management]] are flawed.
*[[Richard Bookstaber]]<ref name="Fridson">{{cite web|last1=Fridson|first1=Martin S.|title=A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation (A review)|url=https://rpc.cfainstitute.org/research/financial-analysts-journal/2007/a-demon-of-our-own-design-markets|website=[[CFA Institute]]|publisher=cfainstitute.org|accessdate=4 July 2025}}</ref>  [[A Demon of Our Own Design|submits that]] the more intricate risk-management structures may actually make the financial system more vulnerable.

The [[financial innovation]] often associated with financial engineers was mocked by former chairman of the Federal Reserve [[Paul Volcker]] in 2009 when he said it was a code word for risky securities, that brought no benefits to society. For most people, he said, the advent of the [[Automated teller machine|ATM]] was more crucial than any [[asset-backed security|asset-backed bond]].<ref>{{cite news |url=http://uk.reuters.com/article/usa-economy-volcker-idUKN2029103720090220 |title=Crisis may be worse than Depression, Volcker says |date=Feb 20, 2009 |publisher=Reuters |access-date=2013-09-05 |archive-url=https://web.archive.org/web/20130928083853/http://uk.reuters.com/article/2009/02/20/usa-economy-volcker-idUKN2029103720090220 |archive-date=2013-09-28 |url-status=dead }}</ref>

==Education==
{{Further |Outline of finance #Education|Quantitative analysis (finance) #Education}}
The first [[Master of Financial Engineering]] degree programs were set up in the early 1990s. 
The number and size of programs has grown rapidly, to the extent that some now use the term "financial engineer" to refer to a graduate in the field.<ref name="IAFE" /> 
The financial engineering program at [[Polytechnic Institute of New York University|New York University Polytechnic School of Engineering]] was the first curriculum to be certified by the [[International Association of Financial Engineers]].<ref>{{Cite web |url=http://www.poly.edu/academics/departments/finance |title={title} |access-date=2013-04-25 |archive-url=https://web.archive.org/web/20130410150319/http://www.poly.edu/academics/departments/finance |archive-date=2013-04-10 |url-status=live }}</ref><ref>{{cite web| url = http://archive.poly.edu/fe/people/faculty/adjunct/index.php| title = The Department of Finance and Risk Engineering| publisher = Polytechnic Institute of NYU| access-date = 2012-05-09| archive-url = https://web.archive.org/web/20140104064953/http://engineering.nyu.edu/academics/departments/finance?old=fe%2Fpeople%2Ffaculty%2Fadjunct%2Findex.php| archive-date = 2014-01-04| url-status = live}}</ref>
The number, and variation, of these programs has grown over the decades subsequent (see {{section link|Master of Quantitative_Finance#History}}); and lately includes undergraduate study, as well as [[Professional certification in financial services|designations]] such as the [[Certificate in Quantitative Finance]].

==See also==
{{div col}}
*[[Actuarial science]]
*[[Computational finance]]
*[[Financial modeling]]
*[[List of finance topics]]
*[[Mathematical finance]]
*[[Quantitative analyst]]

{{div col end}}

==References==
{{Reflist}}

==Further reading==
*{{cite book|last1=Beder|first1=Tanya S.|last2=Marshall|first2=Cara M.|title=Financial Engineering: The Evolution of a Profession|publisher=John Wiley & Sons|year=2011}}
*{{cite book |last1=Marshall |first1=John F. |last2=Bansal |first2=Vipul K. |title=Financial engineering: a complete guide to financial innovation |date=1992 |publisher=New York Institute of Finance |location=New York |isbn=978-0133125887}}
*{{cite book |last1=Orlando |first1=Giuseppe |last2=Bufalo |first2=Michele |last3=Zurlo |first3=Concetta |last4=Penikas |first4=Henry |title=Modern financial engineering: counterparty, credit, portfolio and systemic risks |date=2022 |publisher=World Scientific |location=Singapore |isbn=978-981-12-5235-8}}
{{Finance}}

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[[Category:Mathematical finance]]
[[Category:Engineering disciplines]]