What is Financial Mathematics?
Introduction
• Financial Mathematics is a collection of mathematical techniques that find applications in finance, e.g. – Asset pricing: derivative securities. – Hedging and risk management – Portfolio optimization – Structured products
• There are two main approaches: – Partial Differential Equations – Probability and Stochastic Processes
Short History of Financial Mathematics
• 1900: Bachelier uses Brownian motion as underlying process to derive option prices.
• 1973: Black and Scholes publish their PDE-based option pricing formula.
• 1980: Harrison and Kreps introduce the martingale approach into mathematical finance.
• Financial Mathematics has been established as a separate academic discipline only since the late eighties, with a number of dedicated journals.
Structure of this talk
• Preliminary notions: Time value of money, financial securities, options.
• Arbitrage and risk–neutral valuation
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