RMSC 4003 Statistical Modeling in Financial Markets

Syllabus

Department of Statistics
The Chinese University of Hong Kong

2020/21 Term 1

Dr. LEE Pak Kuen, Philip

(If pandemic stabilizes and University announces that face-to-face teaching is
possible: Lectures: all face-to face, Tutorial class: all online)
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Philip Lee (CUHK)
Instructor and Teaching Assistant

• Instructor: Dr. LEE Pak Kuen, Philip

• Email: pklee@sta.cuhk.edu.hk
• Office: Lady Shaw Building, Room 116
• Telephone No.: 3943 7943

• Teaching Assistant: Mr. LEUNG, Cheuk Wai Dominic

• Email: 1155093086@link.cuhk.edu.hk
• Office: Lady Shaw Building, Room G32
• Telephone No.: 3943 8535

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Philip Lee (CUHK)
Prerequisites
• Risk Management: RMSC 2001 or consent of the instructor
Additional Knowledge Required:
• Statistics: STAT 2001 and STAT 2006
• Mathematics: MATH1010 and MATH1030
• Finance: FINA2010
Example: How future contracts are traded, difference
between forward and future contracts, Black-Scholes
Option Pricing, … etc

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Philip Lee (CUHK)
RMSC4003/4001 or “RMSC3003/3001”?
Year 2 & Year 3 Year 3 Year 4 Year 4
Year 3 Term1 Term1 Term2 Term1 Term2

RMSC2001 Elective Courses

FINA2010 RMSC4003 RMSC4001 RMSC4007

FINA3080
RMSC4002 RMSC4004
Question: Why not
STAT2001 RMSC3003 and RMSC3001? RMSC4005
- Substantially more difficult
STAT2006 than other 3000 levels
courses Capstone Courses
STAT3008
- A lot of background
knowledge are required RMSC4202
=> Discourage non-major and RMSC4102
minor students to enroll the
course in the 3rd year

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Philip Lee (CUHK)
Reference Books
Reference #1: Investment Science, 7th Edition
David G. Luenberger, Oxford University Press

Reference #2: Statistics and Finance – An Introduction

David Ruppert
- Highly Statistical: portfolio theory, CAPM, option pricing,
efficient market hypothesis (EMH), financial time series
ARCH/GARCH model

Reference #3: Hedge Funds – An Analytic Perspective

Andrew W. Lo
- Upgrades of Model from RMSC4003, more applicational
- Reading Material for RMSC3101 before
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Philip Lee (CUHK)
Course Outline
• First module: Portfolio Theory
a) Mean-variance Analysis
b) Markowitz Optimal Portfolio for Single-period Investment.
• Second module: Asset Pricing
a) Capital Asset Pricing Model (CAPM)
b) Factor Models
c) Arbitrage Pricing Theory (APT)
• Third module: Stochastic Calculus
a) Brownian Motion, Ito’s Calculus
b) Applications: Black Scholes Models and Option Pricing
c) Applications: Estimation of Realized Volatility
• Miscellaneous Topics: E.g. Kelly Criterion
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Philip Lee (CUHK)
Learning Outcomes
Upon completion of the course, students should be able to
1. explain the notion of variation as a measure of risk and its relationship to statistics and
risk management;
2. demonstrate the ability to understand the concepts of mean-variance analysis and
Markowitz optimal portfolio for a one-period investment;
3. interpret and infer from the mean-variance analysis and the ideas of efficient frontiers
and minimum variance portfolio;
4. understand the notion of factor models and their relationships to linear regressions;
5. relate the celebrated CAPM model with factor models and their statistical
underpinnings;
6. explain the concepts of APT and its reconciliation with the CAPM;
7. explain and demonstrate the basic notions of diffusions and their applications to
finance and risk management;
8. demonstrate a basic understanding of Ito’s calculus;
9. demonstrate a working knowledge of applying Ito’s calculus, in particular with respect
to standard Brownian motion;
10. differentiate both conceptually and practically the notion of integration by parts
between ordinary and Ito’s calculus;
11. apply Ito’s calculus to option pricing and the Black-Scholes formula; and
12. acquire the necessary background for other courses in risk management and finance,
including but not limited to RMSC4001, RMSC4002, RMSC4005 and RMSC4007. 7
Philip Lee (CUHK)
 Assessment Scheme
• Regular assignments: 20%
• Mid-term exam: 35% Nov 10th (Week 10 Tue) during lecture hours
• Final exam: 45%
Regular Assignments: 4 assignments in total
• Late submission: -10 points per day, 0/100 point after the solutions
are posted on Blackboard
Mid-term Exam:
• Online: 2-hr written exam
• Face-to-face: 2-hr written exam, One-page (A4 size, double-sided) formula sheet
Final Exam:
• Online: 2-hr written exam
• Face-to-face: 2-hr centralized exam, One-page (A4 size, double-sided) formula sheet
• Review Sessions before the two exams
• No R Problems in the two exams 8
Grade Descriptor
Grade A
Show an excellent understanding of risk measures and make applications. Demonstrate an excellent understanding of
mean-variance analysis for the management and evaluation of market risks. Provide a sound and cogent explanation of
the notions of diffusions and their relations to finance and risk management. Demonstrate a thorough understanding
of Ito’s calculus with advanced knowledge of its application in pricing financial options via the Black-Scholes formula.
Grade B
Show a satisfactory understanding of risk measures. Demonstrate a satisfactory understanding of mean-variance
analysis for the management and evaluation of market risks. Provide a satisfactory and deductive explanation of the
notions of diffusions and their relations to finance and risk management. Demonstrate a satisfactory understanding of
Ito’s calculus with intermediate knowledge of its application in pricing financial options via the Black-Scholes formula.
Grade C
Show a basic understanding of risk measures. Demonstrate a brief understanding of mean-variance analysis for the
management and evaluation of market risks. Provide a logical explanation of the notions of diffusions and their
relations to finance and risk management. Demonstrate a brief understanding of Ito’s calculus with basic knowledge of
its application in pricing financial options via the Black-Scholes formula.
Grade D
Show little understanding of risk measures. Demonstrate little understanding of mean-variance analysis for the
management and evaluation of market risks. Provide a few explanations of the notions of diffusions and their relations
to finance and risk management. Demonstrate little understanding of Ito’s calculus with some knowledge of its
application in pricing financial options.
Grade F
Fail to understand risk measures. Fail to understand mean-variance analysis. Fail to understand statistical diffusions.
Fail to understand Ito’s calculus.

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Tutorial Sessions
1. One online Tutorial session per week
2. Demonstration of statistical functions in R
• Basic statistical functions, Matrix operations, Optimization
with constraints (for the minimization of portfolio
variance), … etc
3. Additional Examples on the lecture material
4. Hints on homework assignments

Academic Honesty and Plagiarism

• The Chinese University of Hong Kong places very high
importance on honesty in academic work submitted by students,
and adopts a policy of zero tolerance on cheating in examinations
and plagiarism.
• See the following link for details:
http://www.cuhk.edu.hk/policy/academichonesty 10
Philip Lee (CUHK)