Chapter

Milestones in Financial Modeling

Financial Modeling Principles

  1. Sergio M. Focardi PhD1,
  2. Frank J. Fabozzi PhD, CFA, CPA2

Published Online: 15 DEC 2012

DOI: 10.1002/9781118182635.efm0068

Encyclopedia of Financial Models

Encyclopedia of Financial Models

How to Cite

Focardi, S. M. and Fabozzi, F. J. 2012. Milestones in Financial Modeling. Encyclopedia of Financial Models. .

Author Information

  1. 1

    Partner, The Intertek Group

  2. 2

    Professor of Finance, EDHEC Business School

Publication History

  1. Published Online: 15 DEC 2012

Abstract

The origins of financial modeling can be traced back to the development of mathematical equilibrium at the end of the nineteenth century, followed in the beginning of the twentieth century with the introduction of sophisticated mathematical tools for dealing with the uncertainty of prices and returns. In the 1950s and 1960s, financial modelers had tools for dealing with probabilistic models for describing markets, the principles of contingent claims analysis, an optimization framework for portfolio selection based on mean and variance of asset returns, and an equilibrium model for pricing capital assets. The 1970s ushered in models for pricing contingent claims and a new model for pricing capital assets based on arbitrage pricing. Consequently, by the end of the 1970s, the frameworks for financial modeling were well known. It was the advancement of computing power and refinements of the theories to take into account real-world markets starting in the 1980s that facilitated implementation and broader acceptance of mathematical modeling of financial decisions.

Keywords:

  • Pareto law;
  • theory of point processes;
  • utility index;
  • mean-variance analysis;
  • perfect market;
  • Modigliani-Miller theorems;
  • absence of arbitrage;
  • efficient market;
  • capital asset pricing model;
  • systematic risk factors;
  • nondiversifiable risk factors;
  • unsystematic risk factors;
  • diversifiable risk factors;
  • arbitrage pricing theory model;
  • equivalent martingales