Derivatives and Internal Models: Modern Risk Management (Finance and Capital Markets Series)

Now in its fifth edition, __Derivatives and Internal Models__ provides a comprehensive and thorough introduction to derivative pricing, risk management and portfolio optimization, covering all relevant topics with enough hands-on, depth of detail to enable readers to develop their own pricing and risk tools. The book provides insight into modern market risk quantification methods such as variance-covariance, historical simulation, Monte Carlo, hedge ratios, etc., including time series analysis and statistical concepts such as GARCH Models or Chi-Square-distributions. It shows how optimal trading decisions can be deduced once risk has been quantified by introducing risk-adjusted performance measures and a complete presentation of modern quantitative portfolio optimization. Furthermore, all the important modern derivatives and their pricing methods are presented; from basic discounted cash flow methods to Black-Scholes, binomial trees, differential equations, finite difference schemes, Monte Carlo methods, Martingales and Numeraires, terms structure models, etc. The fifth edition of this classic finance book has been comprehensively reviewed. New chapters/content cover multicurve bootstrapping, the valuation and hedging of credit default risk that is inherently incorporated in every derivative—both of which are direct and permanent consequences of the financial crises with a large impact on our understanding of modern derivative valuation. The book will be accompanied by downloadable Excel spread sheets, which demonstrate how the theoretical concepts explained in the book can be turned into valuable algorithms and applications and will serve as an excellent starting point for the reader’s own bespoke solutions for valuation and risk management systems. Front Matter ....Pages i-xxxii Front Matter ....Pages 1-1 Introduction (Hans-Peter Deutsch, Mark W. Beinker)....Pages 3-6 Fundamental Risk Factors of Financial Markets (Hans-Peter Deutsch, Mark W. Beinker)....Pages 7-53 Financial Instruments: A System of Derivatives and Underlyings (Hans-Peter Deutsch, Mark W. Beinker)....Pages 55-71 Front Matter ....Pages 73-73 Overview of the Assumptions (Hans-Peter Deutsch, Mark W. Beinker)....Pages 75-77 Present Value Methods, Yields and Traditional Risk Measures (Hans-Peter Deutsch, Mark W. Beinker)....Pages 79-96 Arbitrage (Hans-Peter Deutsch, Mark W. Beinker)....Pages 97-106 The Black-Scholes Differential Equation (Hans-Peter Deutsch, Mark W. Beinker)....Pages 107-122 Integral Forms and Analytic Solutions in the Black-Scholes World (Hans-Peter Deutsch, Mark W. Beinker)....Pages 123-137 Binomial and Trinomial Trees (Hans-Peter Deutsch, Mark W. Beinker)....Pages 139-163 Numerical Solutions Using Finite Differences (Hans-Peter Deutsch, Mark W. Beinker)....Pages 165-206 Monte Carlo Simulations (Hans-Peter Deutsch, Mark W. Beinker)....Pages 207-225 Hedging (Hans-Peter Deutsch, Mark W. Beinker)....Pages 227-251 Martingales and Numeraires (Hans-Peter Deutsch, Mark W. Beinker)....Pages 253-286 Interest Rates and Term Structure Models (Hans-Peter Deutsch, Mark W. Beinker)....Pages 287-351 Front Matter ....Pages 353-353 Simple Interest Rate Products (Hans-Peter Deutsch, Mark W. Beinker)....Pages 355-387 FX Derivatives (Hans-Peter Deutsch, Mark W. Beinker)....Pages 389-397 Variants of Fixed Income Instruments (Hans-Peter Deutsch, Mark W. Beinker)....Pages 399-413 Plain Vanilla Options (Hans-Peter Deutsch, Mark W. Beinker)....Pages 415-439 Exotic Options (Hans-Peter Deutsch, Mark W. Beinker)....Pages 441-469 Credit Risk (Hans-Peter Deutsch, Mark W. Beinker)....Pages 471-487 Front Matter ....Pages 489-489 Fundamentals (Hans-Peter Deutsch, Mark W. Beinker)....Pages 491-519 The Variance-Covariance Method (Hans-Peter Deutsch, Mark W. Beinker)....Pages 521-557 Simulation Methods (Hans-Peter Deutsch, Mark W. Beinker)....Pages 559-567 Example of a VaR Computation (Hans-Peter Deutsch, Mark W. Beinker)....Pages 569-573 Backtesting: Checking the Applied Methods (Hans-Peter Deutsch, Mark W. Beinker)....Pages 575-583 Front Matter ....Pages 585-585 Classical Portfolio Management (Hans-Peter Deutsch, Mark W. Beinker)....Pages 587-619 Attributes and Their Characteristic Portfolios (Hans-Peter Deutsch, Mark W. Beinker)....Pages 621-639 Active Management and Benchmarking (Hans-Peter Deutsch, Mark W. Beinker)....Pages 641-663 Front Matter ....Pages 665-665 Construction of the Yield Curve Universe (Hans-Peter Deutsch, Mark W. Beinker)....Pages 667-699 Volatility (Hans-Peter Deutsch, Mark W. Beinker)....Pages 701-729 Market Parameter from Historical Time Series (Hans-Peter Deutsch, Mark W. Beinker)....Pages 731-751 Time Series Modeling (Hans-Peter Deutsch, Mark W. Beinker)....Pages 753-776 Forecasting with Time Series Models (Hans-Peter Deutsch, Mark W. Beinker)....Pages 777-792 Principal Component Analysis (Hans-Peter Deutsch, Mark W. Beinker)....Pages 793-804 Pre-Treatment of Time Series and Assessment of Models (Hans-Peter Deutsch, Mark W. Beinker)....Pages 805-822 Back Matter ....Pages 823-897 Now in its fifth edition, Derivatives and Internal Models provides a comprehensive and thorough introduction to derivative pricing, risk management and portfolio optimization, covering all relevant topics with enough hands-on, depth of detail to enable readers to develop their own pricing and risk tools. The book provides insight into modern market risk quantification methods such as variance-covariance, historical simulation, Monte Carlo, hedge ratios, etc., including time series analysis and statistical concepts such as GARCH Models or Chi-Square-distributions. It shows how optimal trading decisions can be deduced once risk has been quantified by introducing risk-adjusted performance measures and a complete presentation of modern quantitative portfolio optimization. Furthermore, all the important modern derivatives and their pricing methods are presented ; from basic discounted cash flow methods to Black-Scholes, binomial trees, differential equations, finite difference schemes, Monte Carlo methods, Martingales and Numeraires, terms structure models, etc. The fifth edition of this classic finance book has been comprehensively reviewed. New chapters/content cover multicurve bootstrapping, the valuation and hedging of credit default risk that is inherently incorporated in every derivative--both of which are direct and permanent consequences of the financial crises with a large impact on our understanding of modern derivative valuation. The book will be accompanied by downloadable Excel spread sheets, which demonstrate how the theoretical concepts explained in the book can be turned into valuable algorithms and applications and will serve as an excellent starting point for the reader's own bespoke solutions for valuation and risk management systems.-- Provided by publisher