Financial econometrics studies the quantitative and statistical aspects of economic principles using regression analysis and data sets to understand the interrelated components of the economy. It benefits portfolio and risk management and was developed in the early 20th century by Ragnar Frisch.
Financial econometrics is the discipline that studies the quantitative and statistical aspects of economic principles. As the different facets of the smaller economy are interrelated, some analysis of these relationships is necessary to understand the different individual components and their effects on the overall economy. These data are observable from the normal practices of the various market forces, making experimentation in financial econometrics unnecessary. Additionally, several different models are used to find the economic data that benefits the financial industry 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, 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 necessary information to reach a conclusion about a certain aspect of the market and its connection with the characteristics of another market. Specifically, the regression analysis identifies a variable that depends on the target characteristic, at the same time that it identifies the various independent variables of the market. This helps determine what is called the conditional mean, a way of finding the likely value of a random factor within the economy.
Data sets are another important tool for determining econometric factors. Econometricians can use observable data and compile it into usable formats that provide information. Time series data sets are one example, where certain aspects of the economy, such as the cost of a good or service, are compiled over the course of a specified period of time. As the price fluctuates, the data will allow the researcher to look at other factors that may be responsible for the changes. For example, if the cost of paper falls over the course of ten years, a determination based on outside influences may be made. An econometrician can correlate the data by analyzing the impact of increased household recycling or implementing the effects of reducing the cost of trees with the price changes that occurred.
Financial econometrics developed in the early 20th century primarily through the work of the Nobel Prize winner Ragnar Frisch. He developed the methods for both data sets and regression analysis in the 1920s and 1930s, respectively. Frisch also helped establish the Econometric Society, an organization that helps establish the relationship between mathematics and economics. Modern researchers, such as Professor Lawrence Klein of the University of Pennsylvania, built on these concepts in the 1980s to bring financial econometrics into the computer age with advanced modeling techniques.
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