Statistical Methods for Financial Engineering

In the narrow Wall Street interpretation, financial engineering refers to the creation of more specialized financial securities out of more fundamental assets such as collections of stocks, bonds, currencies, or mortgages. Used this way, the term now inevitably evokes memories of the mortgage pool “tranches” that became famous during the financial crisis of 2008–2009. In this instance, the payment stream from an ensemble of lower quality mortgages was divided into separate sub-streams that were sold individually as newly created fixed income securities. The sum of the parts could then be valued at more than the whole because some of the constructed streams could qualify for higher-grade credit ratings than the original pool.