Forum Views - October 2023
Welcome to interactive presentation, created with Publuu. Enjoy the reading!
10
FORUM VIEWS - OCTOBER 2023
Introduction
Widespread turmoil in the financial markets in 2008 was
quickly followed by accusations of greed and
mismanagement. Risky trading schemes and complex
valuation models involving credit default swaps (CDS),
collateralized mortgage obligations (CMO), collateralized
debt obligations (CDO), and other complex structures were
blamed. A massive government bailout in the banking and
insurance industries was necessary, including at insurance
giant AIG, to prevent a total financial meltdown. These
systemic institutions were deemed too big to fail. The
financial news was quick to say that another round of black-
box quant models and risky derivatives had blown up Wall
Street. How did this happen? Could it have been prevented?
Who is liable? These questions are still being asked, with
concerns about future market disruptions.
This paper is focused on derivatives and model risk.
Quantitative finance is my area of expertise, and I work in
litigation support and with companies to help clarify issues
involving valuation, risk, and strategy. This specialty is
multidisciplinary, involving engineering, quantitative
finance, and technology commercialization law. I am
thankful to my doctoral advisors at the College of Law and
the Whitman School of Management at Syracuse
University who allowed me to pursue my passion where
these disciplines interact, and to the DuPont Company and
General Electric for 14 years of industry experience before
graduate school, this made all the difference.
Options, futures, and other derivative securities are
essential elements of modern finance and can reduce risk
when properly applied. Derivatives are embedded in
financial assets, tangible and intangible property,
structured products, trading and hedging strategies, and
contracts that have flexible terms and conditions. Real
options occur naturally as flexibility and growth
opportunities that can be exercised over time in an
environment of uncertainty.
Derivatives
QUANTITATIVE MODELING RISKS,
FINANCIAL MARKETS, TECHNOLOGY, ML & AI?
Dr. Thomas Murphy
Ph.D., JD, MBA, Chemical Engineer
Valuation Risk & Strategy, LLC
Insurance can be modeled as a put option having an
exercise price equal to the face value of the policy. Any loss
in value of the asset is covered by an increase in value of the
put option. Reinsurance contracts, commonly known as
excess-of-loss contracts, are combinations of long and
short call option positions on layers of potential losses.
Manufacturing companies often rely on the futures market
to lock-in raw material costs, and real options exist in the
flexible operation of physical equipment. An oil refinery
having flexibility to switch inputs and outputs has an
embedded real option to switch when heating oil is in
greater demand than gasoline. Flexibility increases the
value of every asset under conditions of uncertainty. Long-
term contracts contain option-like features, including
volumetric swing components when demand is uncertain.
Contract prices can be tied to an index, or a basket of
Options, futures, and other
derivative securities are essential
elements of modern finance and
can reduce risk when properly
applied. Derivatives are
embedded in financial assets,
tangible and intangible property,
structured products, trading and
h e d g i n g s t r a t e g i e s , a n d
contracts that have flexible terms
and conditions.
(Skaneateles, New York, USA)
Global Insights
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56