Financial Markets In Practice: From Post-crisis Intermediation To Fintechs

by Charles-albert Lehalle (Editor), Amine Raboun (Editor)

Overview

Financial Markets in Practice: From Post-Crisis Intermediation to FinTechs delivers an overview of the development of risk-transformation undertaken by the financial services industry from the perspective of quantitative finance. It provides an instructional and comprehensive explanation of the structure of the financial system as a network of risk suppliers and risk consumers, where different categories of market participants buy, transform, net, and re-sell different kinds of risks. This risk-transformation oriented view is supported by the changes that followed the last global financial crisis: consumers of financial products asked for less complex risk transformations, regulators demanded limiting risks inside financial institutions to the maximum extent possible, and market participants turned to run mass market-like businesses and away from bespoke 'haute couture'-like businesses.This book portrays the network of intermediaries that compose the financial system, describes their most common business models, explains the exact role of each kind of market participant, and underlines the interaction between them. It seeks to reveal the potential disintermediation that could occur inside the financial sector, led by FinTechs and Artificial Intelligence-based innovations.Readers are invited to reconsider the role of market participants in the post-crisis world and are prepared for the next wave of changes driven by data science, AI, and blockchain. Amid these innovations, quantitative finance will be increasingly involved in all aspects of the financial system. This handy resource helps practitioners from both the buy-side and sell-side gain insights to, and provides an overview of, business models in the financial system from an intermediation perspective, and guides students to comprehensively understand the complex ecosystem in which they will evolve.

Product Details

ISBN-13:	9789811252570
Publisher:	World Scientific Publishing Company, Incorporated
Publication date:	09/16/2022
Pages:	364
Product dimensions:	6.00(w) x 9.00(h) x 0.81(d)

Table of Contents

Preface vii

About the Authors xiii

About the Contributors xv

Acknowledgments xvii

From a Quantitative Perspective xxv

1 Financial System as a Network of Intermediaries 1

1.1 Motivation and Objectives 1

1.2 A Tale to Understand the Basic Functioning of the ^Financial System 2

1.3 Why Do We Need the Financial System? 8

1.3.1 Intermediation everywhere 8

1.3.2 Contribution of the financial system to the economic growth 10

1.4 Focus on Two Main Features of Intermediaries 16

1.4.1 Fair dissemination of public information 16

1.4.2 Intermediation of flows 18

1.5 Market Participants 26

1.5.1 The buy side 28

1.5.2 The (agency) sell side 28

1.5.3 Structures 30

1.5.4 Investment banks 31

1.5.5 Market operators and vendors 34

1.5.6 Market makers and proprietary shops 44

1.5.7 Regulators 47

1.6 Intermediation Everywhere 50

1.6.1 Flows of information 51

1.6.2 Flows of capital 55

1.6.3 Flows of risks 58

1.6.4 Flows of fees and markups 60

1.7 Regulating the Interactions Between Intermediaries 63

1.7.1 Restoring and enhancing the resiliency of the banking system 64

1.7.2 Setting up resolution regimes for systemic financial institutions 68

1.7.3 Making the derivatives market more robust 69

1.7.4 Strengthening the supervision of shadow banking 71

1.8 For More Details 76

References 76

2 Intermediation of Trades, Market Microstructure and Liquidity Provision 79

2.1 The Specific Position of Brokers 79

2.1.1 A little bit of history 79

2.1.2 Brokers: The middlemen 81

2.2 Organization Inside a Brokerage Firm 87

2.2.1 Services to corporates 87

2.2.2 Services to investors 89

2.3 Recent Evolutions of Trading 98

2.3.1 Electronification 98

2.3.2 Market fragmentation 102

2.3.3 New participants 107

2.3.4 Reconfiguration of the playing field and potential disinter mediation of brokers 109

2.3.5 Algorithmic trading 112

2.3.6 Market microstructure 118

2.4 Basics of the Price Formation Process 121

2.4.1 When information moves prices 124

2.4.2 When market makers can read information 129

2.4.3 When flows are moving prices 131

2.4.4 The market impact of large orders 134

2.5 Risk Transfer and Liquidity Provision 138

2.6 For More Details 143

References 144

3 Intermediation of Risks Via Structured Products 147

3.1 Structured Products: A Risk Packaging Tool 147

3.2 From Derivatives to Structured Products 149

3.2.1 Role of derivative markets 150

3.2.2 Hedging of derivatives 152

3.3 The Structure of Structured Products 160

3.3.1 Structured products components 161

3.3.2 Main ways to package risk 164

3.4 The Business Model of Structured Products 169

3.4.1 The consumers of structured products 171

3.4.2 The motivations of structured products suppliers 172

3.4.3 The life-cycle of structured products 172

3.4.4 Behind the scene: Index providers and rating agencies 176

3.5 Risk Intermediation Via Structured Products 178

3.5.1 Risk valuation starts at issuance 178

3.5.2 The hedge is not free of charge 180

3.5.3 Effect of structured products replication on prices formation 181

3.6 For More Details 182

References 184

4 Asset Management as an Intermediary Between the Investors and the Real Economy 185

4.1 The Role of Asset Management in the Financial System 185

4.1.1 The contact point between the financial system and the real economy 185

4.1.2 Intermediation by asset managers 192

4.2 Overview of the Asset Management Industry 194

4.2.1 Pension funds 196

4.2.2 Mutual funds 197

4.2.3 Hedge funds (or alternative investments) 199

4.2.4 Sovereign funds 202

4.2.5 Endowment funds 202

4.2.6 Wealth management 204

4.2.7 Insurance companies 204

4.3 Concentration of Assets Towards a Few Strategies and Actors 205

4.3.1 Passive investing takes over active allocation 205

4.3.2 Concentration of power within a handful of asset managing companies 209

4.3.3 Crowdedness and transaction costs 213

4.4 Recent Trends in Investing 216

4.4.1 Factor investing: From portfolio monitoring to portfolio design 217

4.4.2 ESG as a new market trend 226

4.4.3 From portfolio construction to smart beta 231

4.4.4 A factor zoo or a reproducibility crisis? 240

4.5 For More Details 243

References 247

5 Risk Management at the Scale of an Investment Bank 251

5.1 Why Do We Need to Monitor Model Risk? 251

5.1.1 What is a model? 253

5.1.2 What is model risk? 253

5.2 Examples of Model Failures 254

5.2.1 CHF deposit rates 254

5.2.2 The Value-at-risk model 255

5.2.3 Forward rate agreement disruption 258

5.2.4 Collateralized debt obligation 260

5.3 Valuation Models for Structured Products 266

5.3.1 Risk neutral pricing 268

5.3.2 Ito-Taylor expansion 269

5.3.3 Redefining model risk 270

5.3.4 One way market and concentration of risk 270

5.3.5 Model parameters estimation 272

5.3.6 Mark-to-market and mark-to-model 274

5.3.7 Missing risk factor 275

5.3.8 Change of model consensus 277

5.3.9 Change of paradigm 277

5.3.10 Gamma feedback 279

5.3.11 Model risk management framework 281

5.4 For More Details 283

References 284

6 Could AI and FinTechs Disinter mediate Historical Participants? 287

6.1 Impact of "Cheap Intelligence" on the Financial System 288

6.1.1 From learning machines to cheap intelligence 289

6.1.2 AI in the heart of the financial industry: Personalizing the customer experience, improving risk management and bringing prices closer to economic reality 292

6.1.3 AI leads to fragmentation of the sell-side 295

6.1.4 The link between AI and technology is not anecdotal: The players are "platforming themselves" 298

6.1.5 The sources of uncertainty related to AI remain to be mastered 300

6.1.6 Focus on Aladdin and Marquee: Two generations of platforms 302

6.2 From New Technologies to FinTechs 305

6.2.1 A brief history of practices in new technologies 305

6.2.2 Is the financial industry ready to onboard these technologies? 311

6.2.3 Understanding financial disintermediation thanks to two analogies 314

6.3 Focus on the Three Main Expected Areas of Innovations 320

6.3.1 Improving the relationship with clients 320

6.3.2 Better risk intermediation 322

6.3.3 Toward a better connection to real economy 324

6.4 For More Details 325

6.5 Conclusion 326

References 328

Index 331