Financial Mathematics: History,

Ideas, Methods, Financial Industry,

and Recent Developments
Anatoliy Swishchuk
Department of Mathematics and Statistics
University of Calgary

Global Association of Risk Professionals

September 2018
The views expressed in the following material are the
author’s and do not necessarily represent the views of
the Global Association of Risk Professionals (GARP), its
Membership or its Management.

© 2016 Global Association of Risk Professionals. All rights reserved. (12.15.16)

 Financial Mathematics:
History, Ideas, Methods, Financial Industry
and Recent Developments
∗

Anatoliy Swishchuk
Department of Mathematics and Statistics
University of Calgary
Calgary, Alberta, Canada
GARP Luncheon
Calgary, AB, Canada
September 5th, 2018
∗ This research is supported by NSERC
Outline of Presentation

1. Introduction and History of Financial Mathematics (FM)

2. FM and Financial Industry

3. New Directions/Developments in FM

4. Stochastic Modelling of Limit Order Books (LOB)

5. Monday, February 5, 2018-Another ’Black Monday’ ?!

Introduction
 What is it worth?
(’Irises’ (Les Iris)-Vincent van Gogh (1889))
Introduction

• Finance may be defined as the study of how people allocate

scarce resources over time

• The outcomes of financial decisions (costs and benefits) are

-spread over time

-not known with certainty ahead of time, i.e

subject to an element of risk

• Decision makers must therefore

-be able to compare the values of cash-flows at different dates

-take a probabilistic view

Introduction

Thus, financial mathematics is based on the idea in making good

decisions in the face of uncertainty.

As long as uncertainty is involved, the probability theory is one

of the the main instruments in financial mathematics.

One of the key objectives of financial mathematics is also to

understand how to construct the best investment strategies that
minimises risks in the real world.
Introduction

Cardano
(1501-1576)
Girolamo Cardano was probably the first one who explored the ethics of
gambling in his ’Liber de Ludo Aleae’ (’Book on Games of Chance’) of 1564,
which contains the first discussion of the idea of mathematical probability
(fair dice, gambling).
Introduction

Pascal (1623-1662)
Pascal’s Wager (you’ve got nothing to lose by betting that God exists) his-
torically was groundbreaking because it charted new territory in probability
theory, marked the first formal use of decision theory, and anticipated future
philosophies such as existentialism, pragmatism and voluntarism.
Introduction

Galileo Fermat Daniel Bernoulli

(1964-1642) (1601-1665) (1700-1782)

The early development of probability, from Cardano, through Galileo and

Fermat and Pascal up to Daniel Bernoulli, was driven by considering gambling
problem.
Introduction

Jacob Bernoulli
These ideas about probability were collected by Jacob Bernoulli (1654-1705)
(Daniel’s uncle), in his work ’Ars Conjectandi’ (’The Art of Conjecturing’).
He introduced the law of large numbers, proving that if you repeat the same
experiment (say rolling dice) a large number of times, then the observed mean
(the average of the scores you have rolled) will converge to the expected
mean.
Introduction

Pierre-Simon
Laplace
Building on Jacob Bernoulli’s work, probability theory was developed by the
likes of Laplace (1749-1827) in the eighteenth century and the Fisher, Ney-
man and Pearson in the twentieth.
Introduction

For the first third of the twentieth century, probability was as-
sociated with inferring results, such as the life expectancy of a
person, from observed data.

But as an inductive science (i.e., the results were inspired by

experimental observations, rather than the deductive nature of
mathematics built on axioms), probability was not fully inte-
grated into maths until 1933.
Introduction

Kolmogorov
In 1933, Andrey Kolmogorov (1903-1987) identified probability with measure
theory.

Kolmogorov defined probability to be any measure on a collection of events-

not necessarily based on the frequency of events.
Introduction

Why is the measure theoretic approach so important in finance?

Financial mathematicians realised that an asset’s price can be

represented as an expectation under a special probability mea-
sure, called a risk-neutral measure, which bears no direct relation
to the ’natural’ probability of the asset price rising or falling based
on past observations.
History of Financial Mathematics
History of Financial Mathematics

• The history of the modelling of risky asset (stock, foreign

exchange rate, etc. e.g.) prices St begins with Brownian motion
(BM) Bt (or Wiener process Wt) (σ is the volatility or standard
deviation)

St = σBt
 Fig. 1. Path of Foreign Exchange Fig. 2. Path of Brownian Motion
Rate

The two pathes/trajectories look very similar!

History of Financial Mathematics

• The earliest attempts to model BM mathematically can be

traced to three sources, each of which knew nothing about the
others:
History of Financial Mathematics (cntd)

Thiele

• The first source was that of T. N. Thiele (1838-1910) of

Copenhagen, who effectively created a model of BM while study-
ing time series in 1880
History of Financial Mathematics (cntd)

Bachelier

• The second was that of L. Bachelier of Paris (1870-1926), who

created a model of BM while deriving the dynamic behavior of
the Paris stock market, in 1900
History of Financial Mathematics (cntd)

Einstein

• The third was that of A. Einstein (1879-1955), who proposed

a model of the motion of small particles suspended in a liquid, in
an attempt to convince other physicists of the molecular nature
of matter, in 1905
History of Financial Mathematics (cntd)

• Of these three models, those of Thiele and Bachelier had little

impact for a long time, while that of Einstein was immediately
influential

• Peter Bernstein (1992): ’Despite its importance, Bachelier’s

thesis was lost until it was rediscovered quite by accident in
the 1950’s by Jimmie Savage, a mathematical statistician at
Chicago’

• Bernstein relates that Jimmie Savage alerted the economist

Paul Samuelson to Bachelier’s work, who found Bachelier’s thesis
in the MIT library
History of Financial Mathematics (cntd)

• Samuelson published in 1965 two papers of ground breaking

work

• In his papers he gives his economics arguments that prices

must fluctuate randomly, 65 years after Bachelier had assumed
it!

• This paper along with Fama’s work (1965) on the behaviour

of stock prices, form the basis of what has come to be known
as ’the efficient market hypothesis’
History of Financial Mathematics (cntd)

• Samuelson explains that Bachelier’s model failed to ensure that

stock prices always be positive, whereas geometric BM avoids
these pitfalls

• The derivation was almost identical to that used nearly a

decade later to derive the Black-Scholes formula
History of Financial Mathematics (Brief Summary)

Bachelier (1900): uses Brownian motion as underlying process

to derive option price

Black & Scholes(1973): publish their PDE-based option pricing

formula

Harrison & Pliska (1980): introduce the martingale approach

into mathematical finance

Financial Mathematics has been established as a separate aca-

demic discipline only since the late eighties, with a number of
dedicated journals
Financial Mathematics and Financial Industry

• Financial innovation currently has a poor reputation and some

might feel that mathematicians should think twice before be-
coming involved with "filthy lucre".
Financial Mathematics and Financial Industry

However:

• Aristotle tells us that Thales, the father of western science,

became rich by applying his scientific knowledge to speculation

• Galileo left the University of Padua to work for Cosimo II de

Medici, and wrote ’On the Discoveries of Dice’ becoming the
first quant

• Around a hundred years after Galileo left Padua, Sir Isaac

Newton, left Cambridge to become warden of the Royal Mint,
and lost the modern equivalent of £3, 000, 000 in the South Sea
Bubble
Financial Mathematics and Financial Industry (cntd)

• In the 1970s the late Fisher Black of Goldman Sacks, Myron

Scholes of Stanford and Robert Merton of Harvard had figured
out how to price and hedge options in a way that seemed to
guarantee profits.

• The Black-Scholes model has been the quants’ gold standard

ever since.
Financial Mathematics and Financial Industry (cntd)

• But it gets more complicated than that.

• For example:
-markets are not perfectly efficient-priced
-do not always adjust to right level,
-people are not perfectly rational
-distribution of market data do not follow bell-shaped curve.
Fig. 1. Standard Normal and α-Stable Densities
Fig. 2. Tails for Normal and α-Stable Curves
Financial Mathematics and Financial Industry:
Coffee & Volatility Smile

Coffee’s Options

• One consequence of this is sometimes called the ’volatility

smile’, in which options that benefit from market drops cost
more than options that benefit from market rises
Fig. 3. Volatility ’smile’
Fig. 4. Volatility ’smile’ and ’skew’
Fig. 6. Volatility surface
Financial Mathematics and Financial Industry (cntd)

• Another consequence is that when you need financial models

the most,-on days like Black Monday in 1987 when the Dow
dropped 20 percent,-they might break down.

• The risks of relying on simple models are heightened by in-

vestors’ desire to increase their leverage by playing with borrowed
money. In that case one bad bet can doom a hedge fund.
Financial Mathematics and Financial Industry (cntd)

• Dr. Merton and Dr. Scholes won the Nobel in economic science
in 1997 for the stock option model. Only a year later Long
Term Capital Management (LTCM), a highly leverage hedge
fund whose directors included the two Nobelists, collapsed and
had to be bailed out to the tune of $3.65 billion by a group of
banks

• Afterward, a Merrill Lynch memorandum noted that the fi-

nancial models ’may provide a greater sense of security than
warranted; therefore reliance on these models should be limited’
Financial Mathematics and Financial Industry (cntd)

• In 2008, it was hardly unthinkable that a math wizard like

David X. Li might someday earn a Nobel Prize for determining
correlation

• In 2000, while working at JPMorgan Chase, Li published a

paper in The Journal of Fixed Income titled ’On Default Corre-
lation: A Copula Function Approach’. (In statistics, a copula is
used to couple the behavior of two or more variables).
Financial Mathematics and Financial Industry (cntd)

• Li’s formula, known as a Gaussian copula function was a piece

of financial technology that allowed hugely complex risks to be
modelled with more ease and accuracy than ever before.

• Then the model fell apart in 2008-users of Li’s formula had

not expected: The cracks became full-fledged canyons in 2008-
when ruptures in the financial system’s foundation swallowed up
trillions of dollars and put the survival of the global banking
system in serious peril
Financial Mathematics and Financial Industry (cntd)

• How could one formula pack such a devastating punch? The

answer lies in the bond market, the multimillion-dollar system
that allows pension funds, insurance companies, and hedge fund
to lend trillions of dollars to companies, countires, and home
buyers (mortgages)

• Another answer is correlation-the degree to wich one variable

moves in line with another-and measuring it is important part of
determining how risky mortgage bonds are
Financial Mathematics and Financial Industry (cntd)

• The damage was foreseeable and, in fact, foreseen. In 1998,

before Li had even invented his copula function, Paul Wilmott
wrote that ’the correlation between financial quantities are no-
toriously unstable.’, and argued that no theory should be built
on such unpredictable parameters

• ’The relationship between two assets can never be captured by

a single scalar quantity’, Wilmott said.

• ’Li can not be blamed’, says Gilkes of CreditSights. In financial

markets, everybody doing the same thing is the classic recipe for
a bubble and inevitable bust.
Financial Mathematics and Financial Industry (cntd)

• One of the most outspoken critics is Nassim Nickolas Taleb, a

former trader and now a professor at New York University. He
got a rock-star reception at the World Economic Forum in Davos
in 2009.

• In his best-selling book ’The Black Swan’ (Random House,

2007), Dr. Taleb, who made a fortune trading currency on
Black Monday, argues that finance and history are dominated by
rare and unpredictable events
Financial Mathematics and Financial Industry (cntd)

• Steven Shreve, the Orion Hoch Professor of mathematical sci-

ences at Carnegie Mellon University and one of the founders
of Carnegie Mellon’s Bachelor’s, Master’s and Ph.D. programs
in quantitative finance, wrote in his article ’Don’t Blame the
Quants’ (Forbes, 2008):

’The quants know better than anyone how their models can fail.
For banks, the only way to avoid a repetition of the current crisis
is to measure and control all their risks, including the risk that
their models give incorrect results’.
New Directions/Developments in FM
Some Prospectives in Financial Mathematics

• Alternatives to Black-Scholes

-Stochastic volatility models

-Jump-diffusion models

-fractal statistics (applied to many systems in nature and finance,

and popularized by Benoit Mandelbrot of IBM; look the same at
every scale)

-Lévy processes
Fig. 8. Paths of Lévy Processes
Main Original Contributors to the Theory of Lévy Pro-
cesses (1930-1940)

Paul Lévy Alexander Khinchine Kiyoshi Itó

(1886-1971) (1984-1959) (1915-2008)
Some Prospectives in Financial Mathematics

• Stochastic Interest-rate modelling

• Pricing in incomplete markets

• Pricing/measuring/hedging credit risk

• Stochastic correlation models

Some Prospectives in Financial Mathematics (cnt’d)

• Real options

• Entropy-based option pricing

• Non-standard finance (based on non-standard analysis)

• Environmental and Energy Finance

Some Prospectives in Financial Mathematics:
Energy Finance

• Energy Finance-use financial instruments to manage storage

impact, seasonality, mean-reversion, illiquidity, decentralized en-
ergy markets
Some Prospectives in Financial Mathematics:
Environmental Finance

• Environmental Finance-use of financial instruments to protect

the ecological environment (climate exchanges for trading green-
house gases (GHG) in Chicago, Europe, China, Canada, Aus-
tralia)
Some Prospectives in Financial Mathematics:
Energy Finance - Carbon Finance

• Carbon Finance-investments in GHG emission reduction projects

and use financial instruments that are tradable on the carbon
markets
Some Prospectives in Financial Mathematics:
Energy Finance - Weather Derivatives

• Weather Derivatives-use financial instruments to reduce risk as-

sociated with adverse or unexpected weather conditions (deriva-
tives are non-tradable)
Some Prospectives in Financial Mathematics:
Energy Finance - Renewable Energy

• Renewable Energy Finance-use financial instruments to man-

age wind, solar, hydro & marine, water, etc., energy
Some Prospectives in Financial Mathematics:
Systemic Risk, Big Data, Limit Order Books/Markets

• Systemic Risk (very recent)

• Big Data Science-Bid Data in Finance

• Limit Order Books/Markets

Some Prospectives in Financial Mathematics: Systemic
Risk

• Systemic risk, or instabilities, occur in many complex systems:

In ecology (diversity of species), in climate change, in material
behavior (phase transitions), etc. Mathematical methodologies
do overlap

• Two types of trading in equities are widely practiced today:

High-frequency (limit-order and market) trading and statistical
arbitrage or market neutral (generalized) pairs trading

• These types of trading account for well over two thirds the
volume traded today

• It is not yet clear how to quantify the systemic risk, or the

market instabilities generated by these types of trading
Some Prospectives in Financial Mathematics: Big Data in
Finance

Big data has now become a driver of model building and analysis
in a number of areas, including finance.

Main problem: how to deal with big data arising in electronic

markets for algorithmic and high-frequency (milliseconds) trading
that contain two types of orders, limit orders and market orders.

More than half of the markets in today’s highly competitive and

relentlessly fast-paced financial world now use a limit order book
(LOB) mechanism to facilitate trade.
Some Prospectives in Financial Mathematics: Limit Order
Books/Markets

Orders to buy and sell an asset arrive at an exchange:

1. Market buy/sell order - specifes number of shares to be

bought/sold at the best available price, right away.

2. Limit buy/sell order - specifes a price and a number of shares

to be bought/sold at that price, when possible.

3. Order cancellation - agents who have submitted a limit order

may cancel the order before it is executed.
Some Prospectives in Financial Mathematics: Limit Order
Books/Markets II

• Market orders are executed immediately

• Limit orders are queued for later execution, but may cancel

• The Limit-Order Book is the collection of queued limit orders

awaiting execution or cancellation
Some Prospectives in Financial Mathematics: Big Data in
Finance-Lobster Data

Description of a Big Data: LOBster Data

https://lobsterdata.com/info/DataSamples.php
Some Prospectives in Financial Mathematics: Big Data in
Finance-Lobster Data II

Description of the LOBster Data-Actual Files:

http://LOBSTER.wiwi.hu-berlin.de

LOBster generates a ’message’ and an ’orderbook’ file for each

active trading day of a selected ticker. The ’orderbook’ file
contains the evolution of the LOB up to the requested number
of levels. The ’message’ file contains indicators for the type of
event causing an update of the LOB in the requested price range.
All events are timestamped to seconds after midnight, with dec-
imal precision of at least milliseconds and up to nanoseconds
depending on the reuqested period. ’Message’ file-3.3 MB, ’Or-
derbook’ file 4.9 MB, if you print it out (do not do that!)-1,370
pages!!!
Some Prospectives in Financial Mathematics: Big Data in
Finance-Lobster Data III

Description of the LOBster Data:

http://LOBSTER.wiwi.hu-berlin.de
Some Prospectives in Financial Mathematics: Big Data in
Finance-Lobster Data IV

Description of the LOBster Data-Actual Files

http://LOBSTER.wiwi.hu-berlin.de

Snapshot of the ’Orderbook’ file

34200.0175 5 0 1 2238200 -1
34200.1896 1 11885113 21 2238100 1
34200.1902 4 11885113 21 2238100 1
34200.1902 4 11534792 26 2237500 1
34200.3728 5 0 100 2238400 -1
34200.3757 5 0 100 2238400 -1
34200.384 5 0 100 2238600 -1
34200.3858 5 0 100 2238600 -1
34200.3872 5 0 100 2239200 -1
34200.3885 5 0 100 2239300 -1
34200.3914 4 14585251 100 2239500 -1
34200.3914 4 3911376 20 2239600 -1
34200.3914 4 16202496 286 2239600 -1
34200.3935 4 2135294 100 2239900 -1
34200.3944 1 16207239 100 2239900 -1
34200.3985 5 0 100 2239700 -1
34200.3986 5 0 100 2239700 -1
34200.4003 5 0 100 2239700 -1
34200.4015 5 0 10 2239700 -1
34200.4015 4 16207239 90 2239900 -1
34200.4019 1 16208720 50 2239900 -1
34200.403 4 16207239 10 2239900 -1
34200.403 4 16208720 50 2239900 -1
34200.403 4 1365373 13 2240000 -1
Some Prospectives in Financial Mathematics: Big Data in
Finance-Lobster Data V

Description of the LOBster Data-Actual Files

http://LOBSTER.wiwi.hu-berlin.de

Snapshot of the ’Message’ file

2239500 100 2231800 100
2239500 100 2238100 21
2239500 100 2237500 100
2239500 100 2237500 74
2239500 100 2237500 74
2239500 100 2237500 74
2239500 100 2237500 74
2239500 100 2237500 74
2239500 100 2237500 74
2239500 100 2237500 74
2239600 306 2237500 74
2239600 286 2237500 74
2239900 100 2237500 74
2240000 1451 2237500 74
2239900 100 2237500 74
2239900 100 2237500 74
2239900 100 2237500 74
2239900 100 2237500 74
2239900 100 2237500 74
2239900 10 2237500 74
2239900 60 2237500 74
2239900 50 2237500 74
2240000 1451 2237500 74
2240000 1438 2237500 74
Some Recent Discoveries in Financial Mathematics: Semi-
Markov Evolution of Limit Order Books/Markets

Many papers, including R. Cont and A. de Larrard (SIAM J.

Finan. Math, 2013), introduced a tractable stochastic model for
the dynamics of a limit order book, computing various quantities
of interest such as the probability of a price increase or the
diffusion limit of the price process.
Some Recent Discoveries in Financial Mathematics: Semi-
Markov Evolution of Limit Order Books/Markets II

Among the various assumptions made in this article, we seek to

challenge two of them while preserving analytical tractability:

• the inter-arrival times between book events (limit orders, mar-

ket orders, order cancellations) are assumed to be independent
and exponentially distributed

• the arrival of a new book event at the bid or the ask is inde-
pendent from the previous events
Some Recent Discoveries in Financial Mathematics: Semi-
Markov Evolution of Limit Order Books/Markets III

As suggested by empirical observations, we extend R. Cont and

A. de Larrard (SIAM J. Finan. Math, 2013) framework to:

1) arbitrary distributions for book events inter-arrival times (pos-

sibly non-exponential) and

2) both the nature of a new book event and its corresponding

inter-arrival time depend on the nature of the previous book
event.

We do so by resorting to Markov renewal processes to model the

dynamics of the bid and ask queues.
Some Recent Discoveries in Financial Mathematics: Semi-
Markov Evolution of Limit Order Books/Markets IV

We justify and illustrate our approach by calibrating our model

to the five stocks Amazon, Apple, Google, Intel and Microsoft
on June 21st 2012 (Courtesy:
https://lobster.wiwi.hu-berlin.de/info/DataSamples.php).

When calibrating the empirical distributions of the inter-arrival

times to the Weibull and Gamma distributions (Amazon, Apple,
Google, Intel and Microsoft on June 21st 2012), we find that
the shape parameter is in all cases significantly different than 1
(∼ 0.1 to 0.3), which suggests that the exponential distribution
is typically not rich enough to capture the behaviour of these
inter-arrival times.
Numerical Results: Apple Bid

Apple Bid H(1, 1) H(1, −1) H(−1, −1) H(−1, 1)

Weibull θ 75.9 180.9 31.5 78.2
(71.6-80.5) (172.6-189.7) (29.5-33.6) (73.4-83.3)
Weibull k 0.317 0.400 0.271 0.300
(0.313-0.321) (0.394-0.405) (0.267-0.274) (0.296-0.304)
Gamma θ 2187 1860 2254 2711
(2094-2284) (1787-1935) (2157-2355) (2592-2835)
Gamma k 0.206 0.276 0.168 0.196
(0.202-0.210) (0.271-0.282) (0.165-0.171) (0.192-0.199)
Apple Bid: Fitted Weibull and Gamma parameters. 95 % confidence
intervals in brackets. June 21st 2012.
Some Recent Discoveries in Financial Mathematics: Semi-
Markov Evolution of Limit Order Books/Markets V

Comparison of CDFs for Empirical and Theoretical Weibull,

Gamma and Exponential distributions (stock-Google-June 21st
2012-Bid side)
More Data-More Convincing Results

Of course, the five stocks (Amazon, Apple, Microsoft, Intel and

Google) we have chosen are perhaps the most active (at least
on the NASDAQ) and our numerical results might be misleading
when considering more typical stocks.

However, we would like to point out that our assumptions about

the non- Markovian behaviour of the limit order book and non-
exponential distribution of inter-arrival events are valid not only
for those five stocks but also for bunches of many others.
More Data-More Convincing Results: Deutsche Boerse
Group

We used the financial instruments traded on the Xetra and

Frankfurt markets (Deutsche Boerse Group), on September 23,
2013.
(http://datashop.deutsche-boerse.com/1016/en).

The description of all instruments is presented in Table 1 (next

slide): the first column gives the German security identification
number, the second gives the international security identification
number, the third gives the security name, and the last gives the
one common name.
WKN  ISIN  INSTRUMENT NAME  COMMON NAME 

         LIQUID ASSETS: 

A1JEAN  LU0665646815  UBS‐ETF‐MSCI EU.IN.2035 I UBS‐ETF MSCI Europe 

Infrastructure I 
A1JVYM  IE00B7KMTJ66  UBS(I)ETF‐SOL.G.P.GD IDDL Solactive Global Pure Gold 
Miners UCITS ETF 
A1JEAJ  LU0665646229  UBS‐ETF‐MSCI JA.IN.2035 I  UBS‐ETF MSCI Japan 
Infrastructure I 
A1JVYN  IE00B7KYPQ18  UBS(I)ETF‐ Solactive Global Oil Equities 
SOL.G.O.EQ.IDDL  UCITS ETF I 
A1JVCB  IE00B7KL1H59  UBS(I)ETF‐MSCI WORLD  MSCI World UCITS ETF I 
IDDL 

        MEDIUM LIQUID ASSETS 

ETC057  DE000ETC0571  COMMERZBANK ETC UNL.  Coba ETC ‐3x WTI Oil Daily 

Short Index 
ETC015  DE000ETC0159  COMMERZBANK ETC UNL.  Coba ETC ‐1x Gold Daily Short 
Index 
ETC030  DE000ETC0308  COMMERZBANK ETC UNL.  Coba ETC 4x Brent Oil Daily 
Long Index 
A0X8SE  IE00B3VWMM18  ISHSVII‐MSCI EMU SC  iShares MSCI EMU Small Cap 
U.ETF  UCITS ETF 
A0JMFG  FR0010296061  LYXOR ETF MSCI USA D‐EO  Lyxor UCITS ETF MSCI USA D‐
EUR 

      ILLIQUID ASSESTS 

A1JB4P  DE000A1JB4P2  I.II‐IS. D.J.G.S.S.UTS DZ  iShares Dow Jones Global 

Sustainability Screened UCITS 
ETF 
630500  DE0006305006  DEUTZ AG O.N.  DEUTZ AG O.N. 
A1T8GD  IE00B9CQXS71  SPDR S+P GL.DIV.ARIST.ETF SPDR® S&P® Global Dividend 
Aristocrats UCITS ETF 
851144  US3696041033  GENL EL. CO.      DL ‐,06  General Electric STK 
113541  DE0001135416  BUNDANL.V. 10/20  Bundesrepublik Deutschland 
2,250% 9/2020 BOND 
More Data-More Convincing Results: Deutsche Boerse
Group

We divided 15 assets, presented in Table 1, by three groups:

(1) liquid assets (every 372-542 milliseconds (ms) in average an
order arrives), (2) medium liquid assets (every 1392-1415 ms in
average an order arrives), and (3) illiquid assets (every 8392-
8467 ms in average an order arrives).
More Data-More Convincing Results: Deutsche Boerse
Group

Comparisons of ask PDF for the 5 Liquid assets, for the 5 Illiquid
assets and for the 5 Medium Liquid assets show that the best
fit for these set of assets gives the Burr type XII distribution
F (x) = 1 − (1 + xc)−k , (x > 0, c > 0, k > 0, both c and k are shape
parameters, not exponential.

We note, that all graphs contains comparison for empirical, ex-

ponential, Gamma, Weibul, Pareto, Power law and Burr distri-
butions (7 in total).
 Comparison of Ask PDF for the Liquid Stock with WKN: A1JEAN
1.0
0.8
0.6
0.4
0.2

Emprical CDF
Exponential
Gamma
Weibull
Pareto
Power Law
0.0

Burr

0 2 4 6 8 10 12
 Comparison of Ask PDF for Medium LiquidStock with WKN: ETC057
1.0
0.8
0.6
0.4
0.2

Emprical CDF
Exponential
Gamma
Weibull
Pareto
Power Law
0.0

Burr

0 5 10 15 20 25
 Comparison of Ask PDF for Illiquid Stock with WKN: A1JB4P
1.0
0.8
0.6
0.4
0.2

Emprical CDF
Exponential
Gamma
Weibull
Pareto
Power Law
0.0

Burr

0 10 20 30 40
More Data-More Convincing Results: CISCO, Nov 3, 2014

Moreover, we used even one more set of data, namely, CISCO

on Nov 3, 2014, to show that inter-arrival times between limit
orders at the best ask does not follow an exponential distribution
(see next slide).
 Comparison between the Empirical CDF and Exponential CDF of the interarrival between limit orders at the best Ask
1.0
0.8
0.6
0.4
0.2
0.0

0 20 40 60 80 100
Some Recent Discoveries in Financial Mathematics: Semi-
Markov Evolution of Limit Order Books/Markets VI

We now specify formally the "state process", which is semi-

Markov process and which will keep track of the state of the
limit order book at time t (stock price and sizes of the bid and
ask queues),
e := (s , q b, q a),
Lt t t t

where St := (sat + sbt)/2 is a mid-price,

NX
(t)
St := s0 + Xk ,
i=1
Xk = {−δ, +δ}, δ-tick size, qta, qtb are sizes of bid and ask queues,
N (t)-number of price changes (renewal process).
Some Recent Discoveries in Financial Mathematics: Semi-
Markov Evolution of Limit Order Books/Markets VI

In the context of many papers, including Cont and Larrard (SIAM

J. Finan. Math., 2013), this process Le was proved to be Marko-
t
vian. Here, we will need to "add" to this process the process
(Vtb, Vta) keeping track of the nature of the last book event at
the bid and the ask to make it Markovian: in this sense we can
view it as being semi-Markovian. The process:

Lt := (St, qtb, qta, Vtb, Vta)

is Markovian, where Vtb, Vta are processes for events of increase
or decrease the bid or ask queue by 1, respectively.
Some Recent Discoveries in Financial Mathematics: Semi-
Markov Evolution of Limit Order Books/Markets VII

As we mentioned, high-frequency trading happens in millisec-

onds. How we can study the mid-price St?

One of the ways is to look over a larger time scale, e.g., 5, 10 or

20 minutes, i.e., consider time scale nt instead of t, n could be
n = 100, 1000, .., etc.
Some Recent Discoveries in Financial Mathematics: Semi-
Markov Evolution of Limit Order Books/Markets VIII

In this way, the centred and normalized mid-price Stn,

√
[Stn − N (tn) × a]/ n (∗)
can be approximated by a diffusive σB(t) behaviour with a diffu-
sion coefficient σ that can be completely calibrated to the market
data. Here a is a constant.

The error of estimation of comparison of the standard deviation

√
of Stn − N (tn) × a and nσB(t) is approximately 0.08 for Cisco
data (5 days, 3-7 Nov, 2014).
Monday, February 5, 2018-Another Black Monday?!
Stock Market Crash (Monday, Feb 5, 2018): Some Num-
bers

1,175-the number of points Dow Jones fell

100%-the amount the CBOE VIX increase

4.1%-the amount S&P 500 declined

2.71%-10-year Treasury Notes yield down

$4 Trillion - the amount Global Markets saw wiped away

$7,000-approximately what Bitcoin is worth

Stock Market Crash (Monday, Feb 5, 2018): Why it Hap-
pened?

’One of the culprits of the Flash Crash was high-frequency trad-

ing, where computers are programmed to trade a lot of stocks
incredible fast.

It was a bizarre domino effect kicked off by rapid trading algo-

rithms’ (Source: money.cnn.com)
Stock Market Crash (Monday, Feb 5, 2018): Why it Hap-
pened?

"We have created a stock market that moves too darn fast for
human beings", said David Weild IV, founder and chairman of
CEO of Weild & Co. and a former vice chairman of Nasdaq.
"And because of that," he added, "we see shocking results".

"People can make certain calls that computers can’t, and explain
to investors why they should or should not sell their stocks", he
said. "On a day like today, traders may have told their clients
to sit tight."

Computer programs sold off stocks and scared investors.

Stock Market Crash (Monday, Feb 5, 2018): Why it Hap-
pened?

"Some automated sell programs were likely triggered by the con-

traction in the market," explained Jonathan Corpina, a senior
managing partner with Meridian Equity Partners, "those, in turn,
triggered others. They start playing leapfrog with each other.
At a certain point, buyers who were looking for deals also pulled
back, making matters worse. That’s how you get these large
swings in the market".

"The sellers were really convinced at the end of the day that
today was the day to sell," he said.

Corpina did not blame the volatility entirely on electronic trading.

What is driving the big global sell-off?

• Concerns that the Fed will raise rates (The Federal Reserve
combats inflation by raising its interest rates)

• Rising interest rates (When interest rates rise sharply, stocks

often fall)

• Worries about the bond market (bond yields hit a four-year high
Friday, Feb 2; stocks are a higher-risk investment than bonds;
If bond yields start to rise, investors will want to take some of
their money out of stocks and put it into safer bonds)

• Too far, too fast (Stocks have been rising pretty much in a
straight line since November 2016, and that’s not exactly healthy.
A cooling-off period would be a good thing.)
Why Study Financial Mathematics?

• Financial mathematics is interesting because it synthesizes a highly technical

and abstract branch of maths, measure theoretic probability, with practical
applications that affect peoples’ everyday lives.

• Financial mathematics is exciting because, by employing advanced math-

ematics, we are developing the theoretical foundations of finance and eco-
nomics.
Some Sources

• Swishchuk, A. and Vadori, N. (2017): A Semi-Markovian Mod-

elling of Limit Order Markets. SIAM J. Financial Math., 8(1),
240-273.

• Johnson, T. (2009): What is financial mathematics?

(https://plus.maths.org/content/what-financial-mathematics)

• LOBSTER Data: https://lobsterdata.com/info/DataSamples.php

• LOBSTER Files: http://LOBSTER.wiwi.hu-berlin.de

• money.cnn.com
Conclusion
 The End

Thank You for Your Time and Attention!

e-mail: [email protected]

Q&A time!
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