Cutting Edge introduction: systematic systematic factor models
Credit factor models tend to obscure the economics in favour of tractability – and this puts them at odds with rigorous arbitrage-free martingale pricing methods. To resolve this, quants are looking more closely at what a systematic risk factor actually means. Laurie Carver introduces this month’s technical articles
Financial models are often accused of being artificial and out of touch with real, underlying economics. It’s time for quants to take seriously the workings of the engine, critics say – rather than polishing the mathematical chassis.
Credit risk is one area where this was famously the case. Default times were said to be driven by systematic and idiosyncratic factors, with a co-dependence structure provided by a copula function. This did not go well for the industry in 2008, when systematic
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