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Risk Finance and Asset Pricing: Value, Measurements, and Markets


Praise for Risk Finance and Asset Pricing value, measurements, and markets

"An impressive text on financial engineering that stands out as a logical and well-written description of many of the important models in quantitative finance, providing numerous relevant examples and instructive problems that help to drill home these conceptual underpinnings. The combination is especially useful for the pedagogic delivery of materials in financial engineering courses andpractitioner applications of real-world issues. I highly recommend it to enhance student andpractitioner understanding of financial markets."
—Edward I. Altman, Max L. Heine Professor of Finance and Director of Credit and Debt Markets Research Program at the NYU Salomon Center, Stern School of Business

"Recession frequently leads both students and the general public to realize that they have given far from sufficient attention to the role and nature of risk in the arena of investment. All too often, they have been lured to their financial destruction by mysterious types of assets whose nature they did not understand. Students in the fields of finance and investment, in particular, are surely ready for guidance in the field. Here is a book that provides it very effectively. Comprehensive, rigorous, and clearly written, it will be considered indispensible by instructors, students, and thoughtful investors."
—William Baumol, Professor of Economics and Director, C.V. Starr Center for Applied Economics, NYU

"Charles Tapiero has raised masterfully both the essential problems and questions that we are confronting in a post financial crisis world and reveals the many approaches and techniques that can be used to provide answers for better financial risk management."
—Professor Alain Bensoussan, Distinguished Research Professor of Operations Management, Director of the International Center for Decision and Risk Analysis, University of Texas

"Charles Tapiero is a world-renowned scholar who has made numerous contributions in the field of risk management. His book is a timely and much needed integration of the latest developments in theory and practice. Replete with real-world examples, it is a must-read for practitioners, researchers, and students interested in the field of financial engineering and risk management."
—Lorne N. Switzer, Professor of Finance and Associate Director, Institute for Governance in Private and Public Organizations, John Molson School of Business, Concordia University

"Charles Tapiero is one of the best collaborators I ever had. He ferrets out hidden risks and reduces complexity to being tractable. He writes in a clear style without taxing the reader."
—Nassim NiCHOLas Taleb, Author of The Black Swan, Distinguished Professor of Risk Engineering, NYU-Polytechnic Institute

Charles S. Tapiero is the Topfer Distinguished Professor of Financial Engineering and Technology Management at the New York University Polytechnic Institute. He is also Chair and founder of the Department of Finance and Risk Engineering, as well as cofounder and co–Editor in Chief of Risk and Decision Analysis. An active researcher and consultant, Professor Tapiero has published over 350 papers and thirteen books on a broad range of issues spanning risk analysis, actuarial and financial risk engineering, and management, including Risk and Financial Management: Mathematical and Computational Methods, also by Wiley.


Who This Book is For.

How This Book is Structured.

What's on the Companion Website.

Chapter 1: Risk, Finance, Corporate Management and Society.


1.1 Risks Everywhere—A Consequence of Uncertainty.

1.2 Risks and Finance: Basic Concepts.

Example: An IBM day-trades record.

Example: Constructing a portfolio.

1.3 Option Contracts.

Problem 1.1: Options and their Price.

Example: Options and the Price of Equity.

Example: Management Stock Options.

1.4 Options and Trading in Specialized Markets.

1.5 Real Life Crises and Finance.

1.6 The 2008 Meltdown and Financial Theory.

1.7 Finance and Ethics.


Test Yourself.


Chapter 2: Applied Finance.


2.1 Finance and Practice.

2.2 Financial Risk Pricing: A Historical Perspective.

2.3 Essential of Financial Risk Management.

2.4 Technology and Complexity.

2.5 Market Making and Pricing Practice.


Test Yourself.


Chapter 3: Risk Measurement and Volatility.


3.1 Risk, Volatility and Measurement.

3.2 Moments and Measures of Volatility.

Example: IBM Returns Statistics.

Example: Moments and the CAPM.

Problem 3.1: Calculating the Beta of a Security.

3.3 Statistical Estimations.

Example: The AR(1) ARCH(1) Model.

Example: A Garch (1,1) Model.

3.4 High-Low Estimators of Volatility.

3.5 Extreme Measures, Volume, and Intraday Prices.

Problem 3.2: The Probability of the Range.

3.6 Data Transformation.

Example: Taylor Series.

3.7 Value at Risk and Risk Exposure.

Example: VaR and Shortfall.

Example*: VaR, Normal ROR and Portfolio Design.


Test Yourself.


Chapter 4: Risk Finance Modeling and Dependence*.


4.1 Introduction.

4.2 Statistical Dependence.

Example:  Risk Factors Aggregation.

Example: Principal Components Analysis (PCA).

Example: A Bi-Variate Data Matrix and PCA.

Example: A Market Index and PCA.

4.3 Dependence and Copulas.

Example: The Gumbel Copula, the Highs and the Lows.

Example:  Copulas and Conditional Dependence.

Example: Copula and the Conditional Distribution.

4.4 Financial Modeling and Inter-Temporal Models.

4.5 The R/S Index.


Test Yourself.


Chapter 5: Risk, Value, and Financial Prices.


5.1 Value and Price.

5.2 Utility, Risk and Money.

5.3 Lotteries and Utility Functions.

Example: The utility of a lottery.

Example: The power utility function.

Example:  Valuation and the Pricing of Cash Flows.

Example:  Risk and the Financial Meltdown.

5.4 Utility Rational Foundations.

Examples: Specific Utility Functions.

5.5 The Price and the Utility of Consumption.

Example: Kernel Pricing and the exponential utility function.

Example: The Pricing Kernel and the CAPM.

Example:  Kernel Pricing and the HARA utility function.


Test Yourself.


Chapter 6: Applied Utility Finance.


6.1 Risk and the Utility of Time.

6.2 Assets Allocation and Investments.

Example: A Two securities problem.

Example: A 2 stocks portfolio.

Problem 6.1: The Efficiency Frontier.

Problem 6.2: A Two Securities Portfolio.

6.4 Conditional Kernel Pricing and the Price of Infrastructure Investments.

6.5 Conditional Kernel Pricing and the Pricing of Inventories.

6.6 Agency and Utility.

Example: A linear risk sharing rule.

6.7 Information Asymmetry: Moral Hazard and Adverse Selection.

6.8 Adverse Selection.

6.9 The Moral Hazard Problem.

6.10 Signaling and Screening.


Test Yourself.


Chapter 7: Derivative Finance and Complete Markets.

Discrete States.


7.1 The Arrow-Debreu Fundamental Approach to Asset Pricing.

Example: Generalization to n states.

Example: Binomial Option Pricing.

Problem 7.1: The Implied Risk Neutral Probability.

Example: The Price of a Call option.

Example:  A generalization to multiple periods.

Problem 7.2: Options and their Prices.

7.2 Put Call Parity.

Problem 7.3: Proving the Put-Call Parity.

Example: Put Call Parity and Dividend Payments.

Problem 7.4: Options PUT-CALL Parity.

7.3 The Price deflator and the Pricing Martingale.

7.4 Pricing and Complete Markets.

7.5 Options Galore.

Example: Look-Back Options.

Example: Asiatic Options.

Example:  Exchange options.

Example:  Chooser Options.

Example: Barrier and Other Options.

Example: Passport Options.

7.6 Options and Their “Real Uses”.

Example: Pricing a Forward.

Example: Pricing a floating rate bond.

Example: Pricing fixed rate bond.

Example: The Term Structure of Interest Rate.

Problem 7.5: Annuities and Obligations.

7.7 Pricing and Franchises with a Binomial Process.

7.8 Pricing a Pricing Policy.

7.9 Options Trading, Speculation, and Risk Management.

Example: Options and Trading Practice.

Example: Insuring and derivative hedges.

Problem 7.6: Portfolio Strategies.


Appendix A: Martingales.

Example: Change of Measure in a Binomial Model.

Example: A Two Stages Random Walk and the Radon Nikodym Derivative.

Appendix B: Formal Notations, Key terms and Definitions.

Test Yourself.


Chapter 8: Options Applied.


8.1 Introduction.

8.2 Optional Applications.

Problem 8.1: Pricing a Multi Period Forward.

Example:  Options Implied insurance pricing.

8.3 Random volatility and options pricing.

8.4. Real Assets and Real Options.

8.5 The Black Scholes Vanilla Option and the Greeks*.

8.6 The Greeks and Their Applications.


Test Yourself.


Chapter 9: Credit Scoring and the Price of Credit Risk.


9.1 Credit and Money.

9.2 Credit and Credit Risk.

9.3 Pricing Credit Risk: Principles.

9.4 Credit Scoring and Granting.

9.5 Credit Scoring: Real- Approaches.

Example: A Separatrix.

Example: The Separatrix and Bayesian Probabilities.

9.6 Probability Default Models.

Example: A Bivariate Dependent Default Distribution.

Example: A Portfolio of default loans.

Example: A Portfolio of dependent default loans.

Problem 9.1: The joint Bernoulli default distribution.

9.7 Credit Granting.

Example: Credit Granting and Creditor’s Risks.

Example: A Bayesian default model.

Example: A Financial Approach.

Example: An Approximate Solution.

Problem 9.2: The rate of return of loans.

9.8 The Reduced Form (Financial) Model.

Example: Calculating the spread of a default bond.

Example:  The Loan Model Again.

Example: Pricing default bonds.

Example: Pricing default bonds and the hazard rate.

9.9 Examples.

Example: The bank interest rate on a house loan.

Example: Buy insurance to protect the portfolio from loan defaults.

Example: Use the portfolio as an underlying and buy or sell derivatives on this underlying.

Problem: Lending rates of returns (T.S. Ho and E.O. Vieira).

9.10 Credit Risk and Collaterals Pricing.

Example: Hedge funds rates of returns.

Example: Equity Linked Life Insurance.

Example: Default and the price of homes.

Example: A banks profit from a loan.

9.11 Risk Management and Leverage.


Test Yourself.


Chapter 10: Multi-Names and Credit Risk Portfolios.


10.1 Introduction.

10.2 Credit Default Swaps.

Example: Total Returns Swaps.

Example: Pricing a project launch.

10.3 Credit Derivatives: A Historical Perspectives1.

10.4 CDOs: Examples and Models.

Example: Collateralized Mortgage Obligations (CMOs).

Example: Insurance and Risk Layering.

Example: A CDO with numbers.

Example: The CDO and SPV (BNP Paribas, France).

Example: A Synthetics CDO.

Example: A Portfolio of Loans, VaR and the Normal Approximation.

Example: Insurance and Reinsurance and Stop/Excess Loss Valuation.

10.5 Constructing a Credit Risk Portfolio and CDOs.

Example: A Simple Portfolio of Loans.

Example: Random and Dependent Default.

Example: The KMV Loss Model.


Test Yourself.


Chapter 11: Engineered Implied Volatility and Implied Risk Neutral Distributions*.


11.1 Introduction.

11.2 The Implied Risk Neutral Distribution.

Example: An Implied Binomial Distribution.

Example: Calculating the implied risk neutral probability.

11.3 The Implied Volatility.

Example: The implied volatility in a lognormal process.

11.4 Implied Distributions: Parametric Models.

Example: The Generalized Beta of the second kind.

11.5 A-parametric Approach and the Black-Scholes Model.

Example: The Shimko technique.

11.6 The Implied Risk Neutral Distribution and Information Discrimination.

Example: Entropy in discrete states.

Example: Discrimination Information and the Binomial Distribution.

Problem 11.1: The Lognormal model and discrimination information.

11.7 The Implied Risk Neutral Distribution and its Implied Utility.

Example: Discrimination Information as a utility objective.


Appendix A: The Implied Volatility—The Dupire Model*.

Test Yourself.



About the Author.