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Computer Simulation of the Financial Markets

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This talk starts with a brief introduction to the Financial Services Knowledge Transfer Network (KTN), which is the ESRC ’s delivery vehicle to ensure “impact” in all research relating to financial services. The main section of the talk then focuses on one area of specific concern to industry – understanding the dynamic behaviour of the financial markets. Over the past decade the international financial markets have become increasingly vulnerable to global contagion – due to factors that include increased connectivity and novel financial instruments. Complex financial instruments that were designed with the intention of spreading risk (and thereby reducing risk per institution) perversely increased risk for all as the markets destabilised. It is conjectured that the international markets are now increasingly liable to move into non-equilibrium states, and that understanding of the non-equilibrium states is therefore of overriding importance not only to financial institutions but also to economies and governments. Equilibrium states are reasonably well understood and amenable to standard economic models. But the non-equiibrium states are intractable to such methods. One solution is to use computer simulation, which has been used successfully in many other industries, and has already been used in small-scale models by several economists. In this talk I will describe how such computer models and simulations work; how they differ from traditional analytical methods; how they harness “artificial intelligence” technology such as Genetic Algorithms and Genetic Programming; what types of question they can answer; and what types of question they can never answer. The talk ends with a conjectured view of the future – of the potential for massive simulations of non-equilibrium dynamics to answer questions about systemic stability at a global level. I will describe what level of computer resource would be necessary (and the extent to which it exists), and the level of multi-disciplinary collaboration that would be required.

This talk is part of the Cambridge Finance Workshop Series series.

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