Background and Motivation

Alexander Denev

The aim of this book is to share with the community of practitioners and academics working in finance a new technique that can be applied to a variety of everyday challenges whose solutions appear not to be fully satisfactory. This is the eponymous probabilistic graphical models (PGMs) technique.

PGMs have already been applied extensively in other domains, such as computer science, engineering and medicine, and only recently found their way into finance through the use of Bayesian nets (BNs) (a type of PGM) to stress testing and asset allocation (see, for example, Rebonato 2010; Rebonato and Denev 2014). This book extends these previous works to other types of PGMs and will show a novel range of applications. Since this is still an emerging field, many of the possible uses of PGMs are still being explored. This book gives a snapshot of the research available at the time of writing and suggests possible next steps.

This book is aimed at quants, actuaries and anyone who understands the basics of probability theory and statistics. The theory behind asset pricing will also be required for some of the applications. In fact, we shall introduce the change from the real-world to risk