This is how space begins, with words only
So what is financial engineering? In a logically consistent world, financial engineering should be layered above a solid base of financial science. Financial engineering would be the study of how to create functional financial devices – convertible bonds, warrants, synthetic CDOs, etc. – that perform in desired ways, not just at expiration, but throughout their lifetime. That’s what Black-Scholes does – it tells you, under certain assumptions, how to engineer a perfect option from stock and bonds.
But what exactly is financial science?
Canonical financial engineering or quantitative finance rests upon the science of Brownian motion and other idealizations that, while they capture some of the essential features of uncertainty, are not finally very accurate descriptions of the characteristic behavior of financial objects. (…) Markets are filled with anomalies that disagree with standard theories. Stock evolution, to take just one of many examples, isn’t Brownian. We don’t really know what describes its motion. Maybe we never will. And when we try to model stochastic volatility, it’s an order of magnitude vaguer. (…)
If you’re going to work in this field, you have to understand that you’re not doing classical science at all, and that the classical scientific approach doesn’t have the unimpeachable value it has in the hard sciences.
