Financial econometrics studies the statistical aspects of economic principles, using regression analysis and data sets to understand the interconnectedness of different components of the economy. It is useful in portfolio and risk management, and was developed in the early 20th century by Nobel laureate Ragnar Frisch.
Financial econometrics is the discipline that studies the quantitative and statistical aspects of economic principles. Since the different aspects of the smaller economy are interconnected, some analysis of these relationships is needed to understand the different individual components and their effects on the wider economy as a whole. These data are observable from the normal practices of various market forces, making experimentation in financial econometrics superfluous. Additionally, several models are used to find the economic data that benefits the financial sector and investment research in general. The most beneficial aspect of this discipline can be seen in the fields of portfolio management and risk management.
Econometricians, the people who study financial econometrics, primarily use a principle known as regression analysis to model and analyze the components of the economy. Statistical analysis and targeting of different variables provides researchers with the information needed to draw conclusions about a certain aspect of the market and its connection with the characteristics of another market. Specifically, the regression analysis identifies a variable dependent on the target characteristic, while also identifying the various independent variables of the market. This helps determine what is called a conditional average, a way of finding the probable value of a random factor within the economy.
Data sets are another important tool for determining econometric factors. Econometricians can take observable data and compile it into usable formats that provide information. Time-series datasets are one example, where some aspect of the economy, such as the cost of a good or service, is compiled over the course of a specific time period. As the price fluctuates, the data will allow a researcher to look at other factors that may be responsible for the changes. For example, if the cost of paper decreases over ten years, a determination can be made based on external influences. An econometrician can correlate the data by analyzing the impact of increasing household recycling or implementing the effects of lowering the cost of trees with the price changes that have occurred.
Financial econometrics was developed in the early 20th century primarily through the work of Nobel laureate Ragnar Frisch. He developed the methods of both dataset and regression analysis in the 1920s and 1920s, respectively. Frisch also helped create the Econometric Society, an organization that helps establish the relationship between mathematics and economics. Modern researchers, such as University of Pennsylvania professor Lawrence Klein, built on these concepts in the 1930s to move financial econometrics into the computer age with advanced modeling techniques.
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