Kalman filter in electronic trading

The famous lyrics “Fly me to the moon, let me play among the stars” by Frank Sinatra could perfectly describe our learning journey during our recent Cass quants workshop.

I am Evangelos Santas, studying MSc Financial Mathematics (2020) and one of six Presidents of the newly rising society at Cass: AIR-Q Society. In January, we held the Quant workshop “Kalman Filter in Electronic Trading” in which we discovered the algorithm used in the Apollo 11 mission and learned about the wider applications of the Kalman filter.

The event was a great success, and we welcomed a very special guest: Dr Veronika Lunina, Quantitative Vice President at NatWest Markets. She spoke passionately about the Kalman filter, an important algorithm used in statistics and control theory and its applications in finance.

Kalman filter and the Apollo 11 mission

Dr Lunina piqued interest of all attendees with the Kalman filter’s wide applications starting from the famous Apollo 11 navigation system that took Neil Armstrong to the Moon and most importantly, brought him back!

There are many different applications in technology, control systems and, most recently, finance – especially electronic trading. Veronika discussed the intuition and the theoretical foundations behind the Kalman filter.

She put together an Excel example of estimating a time-varying cointegration coefficient between two financial price series using Kalman filter (e.g. for the purpose of pairs trading) and compared it to a rolling-regression estimate.

Veronika discussed practical challenges of choosing parameter matrices, drawing on her own practical experience, and illustrating for us how different choices lead to different outcomes. She stressed how financial data is inherently noisy and that while Kalman filter may work extremely well for engineering applications with good knowledge of the underlying physics, it is no magic and we should exercise discretion when applying the methodology in the financial domain. With that said, Veronika was positive about her own experiences using extended Kalman filter for automated marking of FX implied volatility surface.

Quantitative jobs and career progression in finance

After a short coffee and cake break, Dr Lunina opened the floor for an informative and helpful Q&A on quantitative jobs and career progression in finance.

She openly shared her own professional experiences and gave some helpful advice on how to be successful as a quant. I particularly liked how she emphasised that we can shape our jobs. We are in charge of our own careers and must be positive and proactive about advancing it on daily basis. Her own work and experiences were informative and insightful and helped us raise our commercial awareness around the Quantitative Finance industry.

Veronika discussed different types of quantitative roles and the ever-changing skillsets required. She then talked about what to expect from a quant recruitment process and gave advice for interviews. She shared several tips and gave examples for how to solve problems by breaking them down into simpler ones, by applying backward induction and symmetry arguments.

As a gift, our guests kindly offered three quants books, “The Man Who Solved the Market” by David Zuckerman, “The Quants by Scott Patterson” and “My Life as a Quant” by Emanuel Derman – to three attendees who most actively participated during the talk and the Q&A session.

Thanks to AIR-Q and Cass!

After the end of the workshop we shared some laughs and interesting stories with our guest over drinks at the networking session in the Cass milling area.

The Presidents of the Cass AIR-Q Society Rocio Plasencia, Juan Sebastian De La Torre, Evangelos Santas, Lucy Nondi, David Flanigan, Adam Upenieks and Peter Vodička would like to deliver special thanks to Dr Veronika Lunina for her amazing presentation and her insightful view on the continuously changing world of Quantitative Finance, especially electronic trading. After the workshop Veronika wrote to us, “I find it very rewarding to teach and was happy there were many challenging questions.”

We would also like to thank Cass Business School for supporting us, then to all our internal members and industry attendees for their valuable contribution. We are looking forward to seeing you all at our next AIR-Q Forums and Workshops that are already on track for the following weeks of the second term.

Evangelos Santas, MSc Financial Mathematics (2020)