Category archives for Risk Management

Historical performance lies! Beware of survivor bias.

Often you find studies how well a specific fund or trading strategy has performed. You must be aware of the fact that basically all studies based on historical data lie – or at least do not tell the full story. There are two highly underestimated effects: Survivor bias and fat tails. Both effects make poor […]

Financial Modelling (with Matlab Source): A great new book

Book Cover

Joerg Kienitz and Daniel Wetterau present “Financial Modelling: Theory, Implementation and Practice with MATLAB Source”, a great resource on state-of-the-art models in financial mathematics. The authors try to bridge the gap between current research topics and an implementation which can be applied in the real world. That means the authors are neither afraid of practical […]

Early Exercise: Curse or Blessing

Many financial contracts come with the right of exercising a right prematurely. Such early exercise rights are a clear advantage for the option holder. But, these rights create optimal stopping problems for the contract parties. Is this really an advantage? In the following, I will show you a little example from my last shopping trip and […]

Post Crisis Financial Modelling – What changes?

I recently stumbled upon an interesting book about post-crisis interest-rate modelling. Besides future changes in the LIBOR and possible EURIBOR fixing after the manipulations of the past few years, counter-party default and collateral become important. Changes in Interest-Rate and Credit Instrument Pricing Pre-crisis, there was a risk-free rate on which the market agreed. This way, different […]

What is Model Risk and What Can I Do About it?

Falling Tower of Bricks

Model risk is the risk that the market models in investment banking do not properly reflect the reality. This risk is often neglected or simply ignored. But, it is one of the most important risks as we could see in the mispricing of CDO, ABS, MBS etc at the beginning of the financial crisis (early […]

Expect the Unexpected: Risk Management Must Be Creative

A flying spinning top

Modern risk management is a real challenge. Today, I played with my levitation device. I noticed that most people do not believe that levitation is real. In fact there is a formal proof that levitation in a static magnetic field cannot be stable. This situation is similar to common believes in financial markets. In the […]

What is the Difference Between Risk-Neutral Valuation and Real-World Valuation?

Open door to new life

In option pricing, two technical terms often create confusion. One term is “risk-neutral” and the other “real-word”. You hear these terms in the context of option pricing, backtesting, risk management and hedging. In this article I try to clarify the terminology. Background First, we start with “risk-neutral”. The term risk-neutral refers to option pricing: The […]

What is a Good Design for a Pricing Library? Use a Payoff Description Language

3d lamp with jigsaw puzzle isolated on the white background

A good library design requires a separation of the functionality into modules with an appropriate API. The size of the modules is determined by the application. While for a simple trading application a good API might contain everything from fitting the stochastic processes to pricing an option under a single function, this is completely insufficient for assessing model […]

What would be the effect of the proposed transaction tax on Life Insurance Guarantees?

Under the current stress of the financial crisis, governments all over Europe discuss the introduction of a transaction tax for financial instruments. Especially, the German and French government propose a 0.1% tax on every equity trade and 0.01% tax on derivative instruments. This does not sound large, but what would happen to guarantees of life insurances, e.g. […]

Merry Christmas and a happy new year 2012!

For those how are involved in end-of-year reporting calculations, I wish you successful working days with not too many unforeseeable interruptions and surprises…. For all the others, I wish you a few relaxing days and all the best for 2012! Best wishes, Andreas

How can I visualize my model data in an interactive webpage?

A brilliant website is the perfect example for user friendly interactive data visualization: Gapminder. This website presents statistical data about the countries of the world and how it changes in time. A user-friendly AJAX user interface allows you to get gain new insights exploring this data. They have done a great job. Google bought this […]

A Glimse at Chaos: How can I Implement a Logistic Growth Process in ThetaML?

Logistic_Bifurcation_map

One of the simple models which lead to chaos is the logistic growth process. Using ThetaML, a technology designed for modeling and analyzing stochastic processes, we can implement a very short logistic growth model and get more insight than usual. Logistic growth model Suppose, we insert a simple logistic model: This can be done in […]

MS Excel and Risk Management does not blend, or does it?

In many businesses, the risk management grows from a very simple spread sheet into a complex cash flow model. If this complex cash-flow model stays in Excel, then you get an explosive combination. A conference on risk management with spreadsheet models now focuses on this combination: