Risk Transfer: Derivatives in Theory and Practice


Praise for Risk Transfer

"Culp's book is a masterly account of the economics of risk and the development of derivatives. It is not only soundly based in theory but it serves as a splendid practical guide to the multiplicity of traded risks in the financial markets."
–Sir Alan Walters, Chief Economic Advisor to Margaret Thatcher (1980-85 and 1989) and former Vice Chairman, AIG Trading Group (1990-2000)

"As always, Chris Culp makes me rethink things I thought I already understood. The idea he champions in this book–that derivatives can be viewed through the lens of an asset lending instrument–helps in understanding the behavior of the producers and users of derivatives. And Culp's historical notes add color to the tapestry of risk management."
–Charles Smithson, Managing Director, Rutter Associates

"Derivatives are the highest financial life form on the planet, and Culp does a great job of explaining why. I was especially delighted by Chapter 2, which traces the way we think about risk and uncertainty from Adam Smith (who would have taught at the University of Chicago if he had been born later), through Frank Knight and Bob Lucas. It is a great reminder of why we study economics in the first place. Well done."
–Galen Burghardt, Director of Research, Carr Futures

"Chris Culp's Risk Transfer is an important addition to the literature on derivatives, and not just because it successfully bridges theory and practice. The presentation of the underlying economic thought and academic literature relevant to the broader issues of how we view and treat risk in the economy and in the business world is excellent. It's what makes this new book unique and valuable."
–Wendy L. Gramm, Chairman of Regulatory Studies
Mercatus Center, George Mason University

"Culp's book explains the role derivatives play in our financial system as an invaluable tool for risk transfer in the marketplace. He takes the reader from the macro aspects of derivatives through detailed modern theories, in addition to offering a practical perspective on speculation and hedging. This book is essential for every derivatives professional."
–Dennis A. Dutterer, President and CEO, The Clearing Corporation

CHRISTOPHER L. CULP is an Adjunct Professor of Finance at the University of Chicago's Graduate School of Business, a Principal at Chicago Partners LLC, and, during the winter academic term, a Resident Guest Professor of Risk and Insurance in the Institut für Finanzmanagement at Universität Bern in Switzerland. Culp is an active consultant to various financial and non-financial firms on risk management, financial instrument selection, and capital allocation. In addition, he is an independent non-executive Director of Idaho Power Company, Inc., and IDACORP, Inc., where he is a member of the Audit and Governance Committees of both boards, and he is a Senior Fellow in Financial Regulation with the Competitive Enterprise Institute in Washington, D.C. Culp is the author of two previous books (both published by Wiley), The ART of Risk Management and The Risk Management Process. He recently coedited for Wiley (with William Niskanen) Corporate Aftershock: The Public Policy Lessons from the Collapse of Enron and Other Major Corporations. Culp holds a PhD in finance from the Graduate School of Business of the University of Chicago and a BA in economics from the Johns Hopkins University.
Preface: The Demonization of Derivatives.

Introduction and Structure of the Book.

Mathematical Notation.

PART ONE: The Economics of Risk Transfer.

CHAPTER 1: The Determinants of Financial Innovation.

CHAPTER 2: Risk, Uncertainty, and Profit.

CHAPTER 3: Methods of Controlling Risk and Uncertainty.

CHAPTER 4: Risk Transfer and Contracting Structures.

CHAPTER 5: The Evolution of Derivatives Activity.

CHAPTER 6: Derivatives Trading, Clearance, and Settlement.

PART TWO: Derivatives Valuation and Asset Lending.

CHAPTER 7: Principles of Derivatives Valuation.

CHAPTER 8: Own Rates of Interest and the Cost of Carry Model.

CHAPTER 9: The Supply of Storage and the Term Structure of Forward Prices.

CHAPTER 10: The Term Structure of Interest Rates.

CHAPTER 11: Basis Relations and Spreads.

PART THREE: Speculation and Hedging.

CHAPTER 12: Speculation and the Speculative Risk Premium.

CHAPTER 13: Hedging Objectives.

CHAPTER 14: Hedge Ratios.

CHAPTER 15: Quality Basis Risk.

CHAPTER 16: Calendar Basis Risk.

PART FOUR: Appendixes.

APPENDIX 1: Economic Theory and Equilibrium.

APPENDIX 2: Derivation of the Fundamental Value Equation.

APPENDIX 3: Relation between the Cost of Carry Model and the Fundamental Value Equation.