Think Twice Finance

Is Financial Engineering Dead?

The answer is no. But a thing that many financial specialists associate with financial engineering is dead. I call it financial numerology. What I am talking about is the use of analytical methods to reach conclusions that do not spring directly from good old assumptions of investor rationality; or at minimum, investor rationales.

Two examples come to mind: 1. Data mining models of price formation. 2. Credit scoring models. The profession has long agreed on the fact that lack of investor choice rationales underpinning these two models was a danger. I also think in hindsight most of us underestimated the size of the danger.

The rationale for both models stems from a common source: The desire to use an overwhelming amount of data to address a single decision. And these approaches are dead because they produce highly correlated trades that are self-destructive.

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