Exploring AI's Role in Enhancing Risk Assessment Models in Financial Quantitative Trading

Abstract

The application of Artificial Intelligence (AI) algorithms to financial risk management has fundamentally transformed the nature of risk and the tools being used to control and manage it. This paper examines how AI is deployed to manage market risk, including volatility forecasting, portfolio optimisation, stress testing, and sentiment analysis. While many of these models are well-accepted across the industry and underpin many front-office and risk-management processes, they are often limited in dynamic market environments where traditional linearity doesnt exist and real-time data is king. AI has brought advanced tools that can be applied to large and complex data sets, and that adapt quickly as market conditions change. Reinforcement learning algorithms are now deployed to optimise portfolio weights dynamically. Natural-language processing is also used to augment sentiment analysis, which can be leveraged to assess potential risk. Other forms of AI can be deployed to address challenges that come with more advanced AI models. Explainable AI models provide the opportunity to produce financial outcomes that are more transparent and less opaque while also helping to validate regulatory compliance. Analyzing the applications of AI case studies sheds light on why financial professionals must continue to embrace AI tools, many of which are designed to help them manage risk in an increasingly volatile market environment.