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WHAT QUANTITATIVE FINANCIAL ECONOMICS HAVE TO OFFER…

ECONOMETRIC MODELS AND ECONOMIC FORECASTS ARE BOTH THE SCIENCE AND ART OF BUILDING AND USING MODELS. THE SCIENCE OF MODEL BUILDING CONSISTS OF A SET OF TOOLS, MOST OF THEM QUANTITATIVE, WHICH ARE USED TO CONSTRUCT AND THEN TEST MATHEMATICAL REPRESENTATIONS OF PORTIONS OF THE REAL WORLD.

THE DEVELOPMENT AND USE OF THESE TOOLS ARE SUBSUMED UNDER THE SUBJECT HEADING OF ECONOMETRICS.

MODELS ARE BUILT IN BUSINESS, ECONOMICS, AND THE SOCIAL SCIENCES IN GENERAL.

THEY MIGHT INCLUDE MODELS OF AGGREGATE ECONOMIC ACTIVITY; THE SALES OF AN INDIVIDUAL FIRM, OR A POLITICAL PROCESS.

ALSO, TODAY THE BENEFITS TO USING SPREADSHEET MODELING FOR FINANCIAL MANAGEMENT AND VALUATION ARE UNDISPUTED IN THE WORLD OF FINANCE, PORTFOLIO MANAGEMENT AND BANKING.

THERE ARE MANY TYPES OF MODELS THAT CAN AND OFTEN HAVE BEEN USED FOR POLICY ANALYSIS AND FORECASTING.

THREE TYPES OF MODELS ARE GENERALLY USED WHEN IT COMES TO FORECASTING AND ANALYSIS :

  1. TIME-SERIES MODELS.
  2. SINGLE-EQUATION REGRESSION MODELS.
  3. MULTI-EQUATION SIMULATION MODELS.

WHEN MAKING A FORECAST, IT IS IMPORTANT TO PROVIDE A STATISTICAL MEASURE OF CONFIDENCE TO THE USER OF THE FORECAST.

ONCE A MODEL HAS BEEN CONSTRUCTED AND FITTED TO DATA, A SENSITIVITY ANALYSIS CAN BE USED TO STUDY MANY OF ITS PROPERTIES.

  • IN TIME-SERIES MODELS, WE PRESUME TO KNOW NOTHING ABOUT THE REAL WORLD CAUSAL RELATIONSHIPS THAT AFFECT THE VARIABLE WE ARE TRYING TO FORECAST. INSTEAD WE EXAMINE THE PAST BEHAVIOR OF A TIME SERIES IN ORDER TO INFER SOMETHING ABOUT ITS FUTURE BEHAVIOR. THE TIME-SERIES METHOD USED TO PRODUCE A FORECAST MIGHT INVOLVE THE USE OF A SIMPLE DETERMINISTIC MODEL SUCH AS A LINEAR EXTRAPOLATION OR THE USE OF A COMPLEX STOCHASTIC MODEL FOR ADAPTIVE FORECASTING.
  • IN SINGLE-EQUATION REGRESSION MODELS, THE VARIABLE UNDER STUDY IS EXPLAINED BY A SINGLE FUNCTION ( LINEAR OR NONLINEAR) OF EXPLANATORY VARIABLES. THE EQUATION WILL OFTEN BE TIME-DEPENDENT, SO THAT ONE CAN PREDICT THE RESPONSE OVER TIME OF THE VARIABLE UNDER STUDY TO CHANGES IN ONE OR MORE OF THE EXPLANATORY VARIABLES.
  • IN MULTI-EQUATION SIMULATION MODELS, THE VARIABLE TO BE STUDIED MAY BE A FUNCTION OF SEVERAL EXPLANATORY VARIABLES, WHICH NOW ARE RELATED TO EACH OTHER AS WELL TO THE VARIABLE UNDER STUDY THROUGH A SET OF EQUATIONS. THE CONSTRUCTION OF A SIMULATION MODEL BEGINS WITH THE SPECIFICATION OF A SET OF INDIVIDUAL RELATIONSHIPS, EACH OF WHICH IS FITTED TO AVAILABLE DATA. SIMULATION IS THE PROCESS OF SOLVING THESE EQUATIONS SIMULTANEOUSLY OVER SOME RANGE OF TIME.

AGAIN, ECONOMIC FORECASTS ARE DERIVED FROM MODELS THAT SIMPLY EXTRAPOLATE THE PAST OR THAT ATTEMPT TO UNDERSTAND THE SOURCES OF PAST CHANGES AND BUILD THEM INTO THE FORECASTS.

INTERPRETATIONS OF ECONOMIC DATA MAY GIVE SOME CLUES AS TO HOW THE FINANCIAL MARKETS WILL REACT, THOUGH MORE OFTEN THAN NOT, THEY ARE EXPLAINING WHY THE MARKETS HAVE ALREADY REACTED AS THEY DID.

REMEMBER WHAT SOMEONE SAID :  IF YOU TORTURE THE DATA LONG ENOUGH, IT WILL CONFESS TO ANYTHING….WHAT WE SAY AT WWW.OFF-THERECORDMESSAGING.COM IS THAT  :

  1. RISK COMES FROM NOT KNOWING WHAT YOU ARE DOING…
  2.  LIFE STILL REMAINS UP TO A CERTAIN EXTENT A SCHOOL OF PROBABILITY…
  3. RISK IS THE OTHER SIDE OF THE COIN…

PHLDUCX

RECOMMENDED READINGS :

  1. ECONOMETRIC MODELS AND ECONOMETRIC FORECASTS BY ROBERT S. PINDYCK AND DANIEL L. RUBINFELD.
  2. FUNDAMENTALS INVESTING BY LAWRENCE J. GITMAN AND MICHAEL D. JOEHNK.
  3. CORPORATE FINANCE BY ROSS, WESTERFIELD AND JAFFE.