25/10/2016

InterviewwithJrgKienitz,coauthorwithDanielWetterauofFinancialModelling:Theory,ImplementationandPracticewithMATLABSourceMoney

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InterviewwithJrgKienitz,coauthorwithDanielWetterauofFinancialModelling:
Theory,ImplementationandPracticewithMATLABSource

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InterviewwithJrgKienitz,coauthorwithDanielWetterauof
FinancialModelling:Theory,ImplementationandPracticewith
MATLABSource.BuythisbookdirectfromWileyandenterpromo
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JacobBettany:ThankyouverymuchforjoiningusJrg.Couldyoubeginbytellingusalittlebitaboutyourself
andyourcolleagueDanielWetterau?
JrgKienitz:Yes,thankyouJacob.Ihaveamathematicalbackground,IstudiedMathandobtainedaPh.D.in
Mathematicsthatwasmainlyintheareasofcomplexanalysis,probabilitytheoryandstochasticanalysis.Afterfinishingmy
studiesIstartedasafinancialconsultantintheendof2000atReutersandthereIhadmyfirstcontactwiththefinancial
industry.LateronImovedtoPostbankSystemswhereIhadanITrole,asaSeniorSystemArchitect,andfinallyIgotmy
roleinDeutschePostbankAG,whereIamnowheadofQuantitativeAnalyticsinthetreasurydepartment.Mycollaborator
MrWetterauisalsoemployedbyDeutschePostbankAG,heworksinmyteamandheisalsoamathematicianwitha
backgroundinmathematicsandeconomics.
JB:Youwritethatthegoalofthebookistofillagapintheliteratureonfinancialmodelling,wouldyoumind
explainingthat?
JK:Thereareseveralreasonswhywewrotethebook.IwasalecturerattheUniversityofBonnandOxfordandcurrentlyI
amdoinglecturesinWuppertal,andtheideawastofamiliarisepeoplewiththeapplicationofmathematicalmethodsin
practice.Thereareofcoursemanybooksavailableonthissubject,butwewantedtowriteabookwhichwasnotsimply
designedforITpeoplesystemsspecialistswhowanttodiveintothesoftwarearchitecturestufforsimplyforpeoplewho
areonlyinterestedinthefinancialmathematicsbackground:wewantedtowritesomethingwhichconnectsbothworldsby
presentingsomereal,challengingproblemsandalsotheimplementationofthesolutions.Oftenbooksonthesetopicsmight
describeelegantorcomplexsoftwareframeworks,butintermofmodelstheyoftenresorttoBlackScholesforconvenience,
ontheotherhand,financialmathematicsbookstendtoexplaintheheavytheorystochasticprocesses,stochasticanalysis
andsoonbutonlyprovideformulasforthemodels.Ouraimthereforewastofillinthegapbycombiningthoseworldsso
wetacklechallengingmodels,forexampletheHestonHullWhiteModel,somecalibrationroutinesforCMScontractsand
theLibormarketmodel,anddemonstratehowsuchmodelscanbeprogrammedintosoftwareusing,inthiscase,MATLAB.
SonotonlydowetaketheBlackScholesmodelasanexamplebutextendtherangeofthemodelstothestateoftheart
withstochasticvolatilitymodels,highdimensionalmodels.Wethendescribethewholedevelopmentworkflowfrommarket
dataanddataanalysis,tomodelchoiceandthederivationofmodelparameters,andthentheuseofmoreinvolved
numericalmethodssuchastheMonteCarlomethodsimulationtotacklethepricingofexoticderivatives,partdependant
derivatives,thederivativeexercisesandsoon.Sothiswastheideabehindthisbook.
JB:SoamIrightinthinkingthatthegapintheliteratureyouidentifycameaboutbecausetheacademicworkis
reallynewandthepracticalworkhasnthappenedyet?

January2014
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"WhatIthinkismissingatthemoment
isthis:Peopleinventnew,cleverideas
usingaheavymathematical
machinery,butfailtoprovidean
exampleacrystallisationpointsay,
liketheinitialcodeforaspecialcaseof
thismodelsothatpeoplecanreally
usethenewideasinComputational
Financeinaverypracticalway."

JK:Wellwecertainlynoticed,throughouracademicandpractical
experience,thatwhenpeopletrytoimplementsomemodelsthey
alwaysreinventthewheel.So,forexample,peoplewhoprogramthe
pricingroutineorthepricingalgorithmfortheHestonstochasticvolatility
modelhavetoimplementthecorrectcharacteristicfunction,Fourier
transformstuffandsoon,andwhatweprovide,foreachmodel,isa
kindofrecipeofhowtodothis,sonobodyhastoreinventthewheelin
practice,peoplecanjustusethealgorithmswhichwehavealready
testedandappliedtofinancialproblems.

JB:WhyMATLAB?Wasthereareasonforchoosingitinthiscontext?
Bookmark&Share

JK:Ourattitudewasthatitwasaniceenvironmentfordevelopingmodelsbecauseyoudonothavetoconcentrateonthe
sideissues.Forinstance,ifyouwanttocalibrateamodelyoucanreallyconcentrateonimplementingthemodelwithout
havingtothinkaboutthealgorithmsdoingtheoptimisationforexample.MATLABoffersalotofoptimisationroutineswhich
arereallyreliableandwhicharefast,whicharetestedandusedbythousandsofpeopleintheindustry.Wethoughtitwasa
goodideatousestandardisedmathematicalsoftware,aprogramminglanguagewhereallthemathematicalfunctionslike
optimisation,likeFouriertransform,randomnumbergeneratorandsoon,areveryreliableandrobust.Thatwaywecould
concentrateonthealgorithmswhicharenecessarytoimplementmodels,andnothavetoworryaboutaprogramminga
randomnumbergeneratororsuchstuff.Thatwasthemainidea,toworkonastronggroundandbuildourhouseonareally
nicefoundation.SothatwastheideaofchoosingMATLAB.
JB:Sothereisalotoffunctionalitybuiltin,youdon'thavetorecreateit.
JK:Yes,thiswasthemainreason.Plusitsveryeasytousethosefunctions.WeusedtoprograminC++forexample,and
VBAofcoursebutinC++youalwayshavetofindsomelibrarywherecertainalgorithmsareprovidedorcreatethemonyour
own,andyouhavetoreallythinkhardaboutthesoftwaredesignandstructure.Matlabpreventsyouhavingtospendquite
somuchtimeinthesoftwaredevelopmentanddesignprocess.It'samorefunctionallybasedapproachwhichcanofcourse
beextendedtoanobjectorientedapproach,butingeneralitsmucheasiertousethatalowerlevellanguagelikeC++.
C++hasmorefeatures,ofcourse,butit'shardtogetfamiliarwithaprogramminglanguagelikethat,youneedalotof
practiceandMATLABismucheasiertolearn,mucheasiertouse.AlsowearedoingourprototypinginMATLABhereatthe
banksowewerequitefamiliarwithMATLABandthiswasanaturalchoiceasweworkwithiteveryday.Bythewayinthe
futureweprovideseveraltrainingcoursesinusingMatlabforfinancialproblemsontheQuantsHubnetwork.
JB:IinterviewedDanielDuffyrecentlyandoneofhisreasonsforchoosingC#ashispreferredprogramming
languagewasthatitintegratedverywellwithotherlanguages,isthatalsotrueforMATLAB?
JK:Yes,youcancompileyourMATLABcodeintoaversionwhichcanbeusedinconnectionwithC++,C#orthedot.net
frameworkfromMicrosoft,forexampleitintegrateswithJavaandyoucanalsobuildstandaloneapplications.Conveniently
youdontneedtohaveaMATLABuserlicencetousethedeployedsoftwareyougetakindofcompiledversionofthe
MATLABkernelwithallthefunctionsinsideandthoughyoucantusetheprogramminglanguageyoucanusethe
functionswhicharedeployed.SopeoplerunningthesoftwareinforexampletheDLLframeworkinMicrosoftExceldonot
havetobuyaMATLABlicencetheyjustgetthedeployedsoftwaretouse.
JB:Howisthebookstructuredandwhydidyoumakethosedecisions?
JK:Thebookisstructuredinthreeparts.Thefirstpartisonavailablemarketdataandfinancialmarkets.Wewantedto
showsomeevidencefortheappearanceofcomplexnonGaussianmodels,soforexamplewelookatvolatilitydynamicsor
volatilitysurfacesandweconsiderthemarketdatafromequityindicesandfixedincome.Afterthatweshowsomediffusion
modelsandtwojumpmodelswhichcansomehowresembletheobservedmarketdataliketheshapeoftheimplied
volatilitysurfacesowecoverpopularmodelslikeHestonorSABR,theVarianceGammamodelandLevymodelswith
stochastictimechangesandweshowthatthemodelscanresemblecertainobservedmarketstructures.

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Inthesecondpartweshowhowpeoplecanusethemodelsbyshowingthenumericalanalysisandcodeforimplementation.
ForexamplewegivepricingformulasforstandardderivativeslikeCallsandPutswhicharenecessaryforcalibratingthese
modelsweshowseveralnumericaltechniqueswhicharequitefastandwhichcanbeextendedtomorecomplexmodelsand
areveryreliable.WealsodemonstratetheMonteCarlosimulationmethodsfortacklingthesemodelsandsoreallythe
secondpartofthebookisontheadvancedmodelsandthedifferentnumericalmethodswhichcanbeused.Weespecially
focusonintegrationandtransformtechniquesandontheMonteCarlosimulation.
PartthreethenisakindofintroductiontotheMATLABprogrammingenvironment,demonstratingwhichtechniquescanbe
implementedinMATLAB.Westartfromtheverybasicstuffwithvariablesandfunctioncallsandsoon,thenweextendthis
tousingclassesandObjectOrientedprogramminginMATLAB.
InthefinalchaptereverythingisgatheredtogetherandwedemonstrateanapplicationofaspecificmodelintheMATLAB
environmentwithanObjectOrientedframeworkforcalibratingoptionsfortheGermanDAXIndex.Weshowstepbystep
howyoucanbuildupanapplicationbydoingthecalibrationandderivingthevolatilitysurfaceforthemodelswehave
introducedinthefirstpart.
So,summarising,thefirstpartconcernsmarketsandmodels,thesecondpartnumericaltechniquesandthethirdpartis
reallyontheapplicationofthesenumericaltechniquesinMATLAB,providinganexamplewhichshowsthewholeworkflow,
whichcanthenbeusedasastartingpointinyourownapplications,orexperimentsorevenproductssuchassoftwareinthe
bankorinsurancecompanyorconsultingbusiness.
JB:Whatwasitlikecollaboratingandwhatwerethemainchallengeswhenwritingthebook?
JK:Collaboratingwaseasybecauseweworkinthesameunitin
Postbankandweseeeachothereverydayandcouldeasilytalkabout
anyproblemsarisingwhenwritingthebook.Ofcoursesometimesitis
hardtopushandpullandmeetdeadlinesandsoon,communicating
withthepublisher.Buttheselectionofthematerialwasprobablythe
mostimportantissue.Thebookisabout850pagesandwedidnot
cover,forexample,suchanimportanttopicasfinitedifference
methods.Alsowestartedtowritethebookin20082009aroundthe
timeofthecreditcrisisandourbookthereforedoesnotincludethenew
marketparadigmsforcollateralisationandthemulticurvestuffwhichis
reallyatopiconitsown.Whatwediddo,whichIthinkisstillvery
important,evenafterthecrash,isreallycoverindepththebasicsofthe
optionpricingmodelandoptionpricingtechniques.
Themulticurveframeworkforexampleisakindofornamentationofthecoreprincipalsintermsofobjectorientedpatterns,
forinstancemulticurveprocessingcanbedonebeforepricingaderivativescontractorincorporatingthisintoexistinginterest
ratemodelsforexample.Thebasictechniquesandcoreprincipalshavestayedthesame,sothebookremainsrelevantafter
thefinancialcrisis.Thesamemathematicalprogrammingtechniquescanalsobeappliedinotherwaysbutthetechniquesas
theyarestayedthesamesothisbookisreallyrelevantbefore,duringandafterthecrisis.

"Practitionersreallyneedtolearnalittle
bitmoreabouttheunderlying
assumptionsandthemathematicsof
themodelstheyuse,whilethosein
academiashouldsomehowbemore
keentoactuallyuseandimplement
modelsonacomputerandtohave
alsoinstilledtheunderstandingintheir
studentsthatprogrammingisareally
usefulskill."

Furthermore,wetacklethepricingofAmericanoptionsusingMonteCarlotechniques,andprovidedifferentmethodsfor
doingthis.Thisisveryimportantnowforcalculatingalltheadjustmentsandthinkingaboutexposuremodelling,calculating
CVAandDVA,FVAandsoon.Thosearenumericaltechniqueswhichareverydemandingandtheyarealsodiscussedin
ourbook.WhenwetalkaboutMonteCarlosimulationsandearlyexerciseopportunities,wetalkaboutexactlythosekindof
algorithmswhichareveryimportantforeverydaylifenowadaystocalculateCVA,etc.Inshort,thetechniquescoveredare
reallyquiteusefulevenafterthecrisis.
JB:Doesthatmeanthattheremightbeanotherbookcoming?
JK:Yeahmaybe!Ithinktherearesomegoodbooksonthistopicbutmaybethereisroomthereforanother!
JB:Whoisthisbookwrittenfor?Howmuchpriorknowledgedoyouneedtounderstandthebook?
JK:Wereallywantedtowriteforbothoftheworldsforthepracticalmindedpeopleandalsoforacademics,sopeoplefrom
theQuantitativeBusinesses,suchasQuants,ConsultantsandRiskManagerscanusethebook,butalsostudentsand
lecturers.Thepracticalguysinbanks,insurancecompaniesandsooncanuseitforfindingacertainmodel,understanding
thepropertiesofthemodel,andthenhavethecodereadilyavailableformodificationortouseasisandapplyitto
everydayproblems.
Ontheotherhandwethoughtthatlecturersmightfindituseful.Ofcourselecturersalwaysuseexamplesintheir
presentationsandmathematicalfinancelecturesandIthinkitwouldbequitebeneficialforpeoplediscussingtheLevy
processesforexample,applicationsinfinance,orstudyingtheDAXoptionsindexpricingtouseourcodeanddemonstrate
tostudentshowitcanbeusedtosolvepracticalproblems.Forstudentsit'salwaysusefultohavesomeimplementationand
guidanceforreallyunderstandingthenumericalstuff.
Ofcoursepeoplecanusethisbookasitis,andnorealpriorknowledgeisneededtoapplythemethodswedemonstrate,
howeverifyouactinthefinancialmarketsyoushouldreallyunderstandthemandwhatyouaredoingifyouapplyamodel.
Youshouldalwayscheckthemodel'sassumptions,whetheritistherightmodel,whichprogramminglanguageisused,and
whetheritisefficientlyprogrammed.Iwouldrecommend,therefore,thatifyoureallydigdeeperintotheapplicationof
modelsyoushouldfamiliariseyourselfwiththemarketandofcoursewiththemathematicalpropertiesofthemodel,thisis
reallynecessary.Thebookcanhelpinbothcaseshere.
JB:WetalkedalittleaboutthebenefitsofMATLAB,couldyououtlineanylimitationsithas?
JK:Yes,ofcourse,onelimitationwouldbetheprice.PeoplewhowanttodevelopinMATLABhavetobuyalicenceandI
wonderifitisaffordableforstudentsbuttherearecertaindiscountsIdon'tknowthepricingmodelbutitmayalsobe
expensiveforcompanieswhohavemanydevelopers.WithotherprogramminglanguageslikeC++orC#,studentscan
downloadafreeversionbutprofessionalversionsarecostlywhen,ifyoureallywantto,youcanuseC++forfree.
MATLABisalsoalittlebitmorelimitedthanC++,JavaandC#inusingObjectOrientedmethodologiesdesignpatterns
andsoonsoifyouwanttodevelopastateoftheartinhouselibraryinanobjectorientedpatternmindedprogramming
language,that'snotMATLAB.AlsoifyouwanttogainmoreefficientprogramsintermsofruntimeC++isunbeatable.
JB:Whatsortofsupportingresourcesareprovidedwiththebook?

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JK:WehaveputourcodeforalltheexampleswhichI'vediscussedonthe
MathWorkshomepage(http://www.mathworks.co.uk/)sothatusershavethe
opportunitytodownloadit,exchangelinksandsoftware.Whenwefind
correctionsneededinthecodeweputthoseonanerratapagemaintainedby
Wiley.Wehavealsosetupanemailaddresswherepeoplecanreachus
kienitzwetterau_financialmodelling@gmx.deiftheyhavequestionsor
problems,oriftheyhaveanynewideas.Iftheyhavecodeorhavedeveloped
theirownapplicationsusingourcodetheycansenditandwewillhavea
look.
JB:I'dliketotalkalittlebitaboutfinancialprogramming,
ComputationalFinanceandthestateoftheartgenerally:What,inyour
view,arethekeydevelopmentsinComputationalFinanceofthelast
decadeandhowdoyouthinkthingswilldevelop?
JK:That'sareallyhardquestion!ComputationalFinancehasmanyfacets
andthereweresomanydevelopmentsinthelastdecade.Someoftheseof
courseweremadeavailablebyusingmoresophisticatedhardwaredesigns,
forexampleparallelprogrammingandGPUprogrammingmadeitreally
possibletorunnumericalexperimentsandexplorenumericalissues,creating
simulationsorsolvinghighdimensionalproblemsinaveryshortamountof
computationaltime.ThisnewtechnologyisIthinkcomplicatedtoprogrambutifyouuseitandgetagriponthistechnology
itwillputyouinanicepositiontodomoresophisticated,morecomplicatednumericalanalysis.
Alsotherehavebeenmanyniceideasfromthemathematicalsidewhichcanbeappliedtofinancialproblemsandwhich
havebeenrealisedincomputeralgorithms,soIseethisalsoasadevelopmentincomputationalfinancealso.Forexample
thereisanicemathematicalideaforanewintegrationformulafortheSABRmodel,basedonRiemanniangeometrywhich
cannowbeimplemented,orthereareotherideasforcalibratinglocalvolatilitiesforexample.Thesealgorithmsappearfirst
asmathematicalideas,thentheymakeitintocomputerprogramsandexpandtherangeofthecurrentavailablemethodsfor
tacklingthesemodels.SoIthinkthesearealsoveryimportantissuesinComputationalFinancenotonlythecomputational
side,thehardwareside,butalsothemathematicalbrainslyingbehindthesealgorithmsandsoftware.
JB:Youtalkedaboutthehardwaredevelopments,doesthebookaddressanyofthat?
JK:WefocusonthemodelsandwedonotreallydiscussanythingintermsofparallelismorGPUcomputing.Wejustfocus
onthealgorithmswhichareneededforimplementingaparticularmodelbutnotreallyonextendingthistomore
sophisticatedhardwaresettings.
JB:ArethereanyareasinComputationalFinancewhichyoufeelareoverratedorgiventoomuchprominencein
thefinancialmedia?
JK:Alwaysinthemarketpeoplelikeacertainmodeloracertainmethodandit'sreallyprominentforawhileandmaybe
lateritturnsoutthatitwasablindalley,butIdon'tthinkthereissomethinginparticularwhichisoverratedatthemoment.
WhatIthinkismissingatthemomentisthis:Peopleinventnew,cleverideasusingaheavymathematicalmachinery,but
failtoprovideanexampleacrystallisationpointsay,liketheinitialcodeforaspecialcaseofthismodelsothatpeople
canreallyusethenewideasinComputationalFinanceinaverypracticalway.Ithinkitwouldbeidealif,whensomeone
inventsanewmodeloranewcalibrationmethodorwhatever,thattheyalsoprovidesomebasiccodesayinC++orin
MATLAB,sothatpeoplecanseeonaverybasiclevelhowthisnewmethodworks.Thiswouldgivepeoplemoreconfidence
inusingthismodelormethodsothattheycanunderstandthebenefitsofimplementingit.SometimesIthinkpeopleworking
inComputationalFinanceputforwardthenicebigmodelbutpeoplearenotreallysurehowtouseitorifitisreally
interestingandreasonabletoimplementthemodel.Theycannotreallyseeitsadvantages,orhowcomplicateditisto
programthemodel.
OfcoursepeoplewillsayitissecrettothebankortotheindustrywheretheyworkbutIthink,especiallyforacademics,it
mightbeagoodideatostructurepapersonthenewmethodsinsuchawaythatpeoplecanreallyputthisintoanalgorithm
inpractice.Thatwouldbeveryusefulandimportantforpractitioners,beingabletoseeanicemethodwrittenupinsucha
waythatpeoplecanreallyadaptittotheirsoftwareframework.Thiswoulddefinitelybeadvantageousforthismodelin
becomingpopularIthink.
JB:ThatsoundslikeapotentialjournalonthepracticalmethodsinComputationalFinance!
JK:Yeswhynot,thatsoundsreallygood!IthinkpeopleworkinginComputationalFinanceinacademiacanreallyenhance
theirworkbygivingsomekindoftipsforimplementingamodelasimplealgorithm,asimpleapplicationIthinkitwould
addtotheknowledgeinthemarket.
JB:Well,that'sgoodtoknow!IwaswonderingifyouhaveanyviewsonhowComputationalFinanceistaught
generally?
JK:Yes,IdopractitionerscoursesandIalsolectureatuniversity,currentlyinComputationalFinanceandIthinkit'svery
important,startingwithacademics,thatontheonehandyougetthenumericaldetailsandthemathematicsright,butonthe
otherhandemphasisethelinktopracticebydoingcomputerexercisesandexperiments.Ofcourseyouneedtolearnthe
theoryandknowhowanalgorithmshouldworkbycalculatingrootsofwhatever,theverybasicstuff,butifyouareforcedto
doityourselfusingsomeprogramminglanguageitgetscomplicated.Ithinkitwouldbeverybeneficialifeverylectureon
ComputationalFinancehadakindofpracticalsessionorapracticalpartforthestudentsapplyingtheirnewknowledgeto
realfinancialmodelsandfinancialproblems.
Sothatsonething,fromanacademicperspective,butontheother
handpractitionersalwaysliketohaveanimplementationofthemodel,
butwhattheyreallyshouldunderstand,foreachmodel,areunderwhat
circumstancesamodeldeliversreasonableresults.So,ifyouthink
aboutthecreditcrisisforexample,thepopularmodel,theGaussian
stuffwasnicebutdidntreallyapplytothestructureswehaveseen.So
assumptionswerenotreallyfulfilledandyoucanonlyjudgeamodel
whenyouknowwhatthemodelwasmadefor,andhowthe
assumptionsforapplyingthismodelarefulfilled.Practitionersreally
needtolearnalittlebitmoreabouttheunderlyingassumptionsandthe

MoreInterviewswithAuthors
Counterpartycreditrisk,collateral
andfundinganinterviewwith
ProfessorDamianoBrigo
AlainRuttiensonhisbook
MathematicsoftheFinancial
Markets:FinancialInstrumentsand

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InterviewwithJrgKienitz,coauthorwithDanielWetterauofFinancialModelling:Theory,ImplementationandPracticewithMATLABSourceMoney
mathematicsofthemodelstheyuse,whilethoseinacademiashould
DerivativesModelling,Valuationand
somehowbemorekeentoactuallyuseandimplementmodelsona
RiskIssues
computerandtohavealsoinstilledtheunderstandingintheirstudents
thatprogrammingisareallyusefulskill.
Moreshouldbedoneatuniversitytoemphasisethispracticalelement.Notsimplythemodellingandthetheory,butalso
doingitonacomputer.
JB:ThatwasveryinterestingJrg,Ireallyappreciateyourtime.
BuythisbookdirectfromWileyandenterpromocodeMON30atthecheckouttoreceive30%offyourcopy.
objectorientedprogramming,java,simulation,computeralgorithms,pricingalgorithm,softwaredesign,software
framework,softwareframeworks,heavymathematicalmachinery,software,bank,softwarearchitecturestuff,insurance,
standardisedmathematicalsoftware,instancemulticurveprocessing,mathematicalfinancelectures,standalone
applications,computing,financialmedia,finance,computationalfinance,softwaredevelopment,deployedsoftware,
danielwetterau,daxoptions,dax30,universityofbonn,deutschepostbankag,gpu,postbanksystems,microsoft,
reuters,montecarlo,matlab,universityofbonnandoxford,departmentofthetreasury,appliedmathematics,
mathematicalsciences,science,mathematicalfinance,actuarialscience,operationsresearch,arrayprogramming
languages,computationalscience,matlab,financialmodeling,impliedvolatility,mathematicaloptimization,jrgkienitz

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