Encyclopedia of Financial Models, 3 Volume Set

2203 Pages·2012·25.05 MB·English

by  Frank J. Fabozzi

ENCYCLOPEDIA
OF
FINANCIAL MODELS
Volume I

ENCYCLOPEDIA
OF
FINANCIAL MODELS
Volume I
FRANK J. FABOZZI, EDITOR
JohnWiley&Sons,Inc.
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About the Editor
FrankJ.FabozziisProfessorofFinanceatEDHECBusinessSchoolandamemberoftheEDHEC
Risk Institute. Prior to joining EDHEC in August 2011, he held various professorial positions in
financeatYaleUniversity’sSchoolofManagementfrom1994to2011andfrom1986to1992wasa
visitingprofessoroffinanceandaccountingatMIT’sSloanSchoolofManagement.From2008to
2011, he was an affiliated professor in the Institute of Statistics, Econometrics, and Mathematical
FinanceattheUniversityofKarlsruheinGermany.Priorto1986heheldprofessorialpositionsat
LafayetteCollege,FordhamUniversity,QueensCollege(CUNY),andHofstraUniversity.From2003
to2011,heservedonPrincetonUniversity’sAdvisoryCouncilfortheDepartmentofOperations
ResearchandFinancialEngineeringandsincethenhasbeenavisitingfellowinthatdepartment.
Professor Fabozzi is the editor of the Journal of Portfolio Management, as well as on the editorial
board of the Journal of Fixed Income, Journal of Asset Management, Quantitative Finance, Review of
Futures Markets, Journal of Mathematical Finance, Journal of Structured Finance, Annals of Financial
Economics,andTheoreticalEconomicLetters.
He has authored and edited a number of books in asset management and quantitative finance.
HiscoauthoredbooksinquantitativefinanceincludeAProbabilityMetricsApproachtoFinancialRisk
Measures (2011), Financial Modeling with Le´vy Processes and Volatility Clustering (2011), Quantitative
EquityInvesting:TechniquesandStrategies(2010),ProbabilityandStatisticsforFinance(2010),Simulation
andOptimizationModelinginFinance(2010),BayesianMethodsinFinance(2008),AdvancedStochastic
Models,RiskAssessment,andPortfolioOptimization:TheIdealRisk(2008),FinancialEconometrics:From
BasicstoAdvancedModelingTechniques(2007),RobustPortfolioOptimizationandManagement(2007),
and Mathematics of Financial Modeling and Investment Management (2004). His books in applied
mathematics include The Methods of Distances in the Theory of Probability and Statistics (2013) and
RobustandNon-RobustModelsinStatistics(2009).HecoauthoredthreemonographsfortheResearch
FoundationoftheCFAInstitute:TheImpactoftheFinancialCrisisontheAssetManagementIndustry
(2010),ChallengesinQuantitativeEquityManagement(2008),andTrendsinQuantitativeFinance(2006).
Professor Fabozzi’s research papers have appeared in numerous journals, including Journal of
Finance,JournalofFinanceandQuantitativeAnalysis,EconometricTheory,OperationsResearch,Journal
ofBankingandFinance,JournalofEconomicDynamicsandControl,StudiesinNonlinearDynamicsand
Econometrics, European Journal of Operational Research, Annals of Operations Research, Quantitative
Finance, European Financial Management, and The Econometric Journal. His 2010 article published
in European Financial Management with Professors Robert Shiller, and Radu Tunaru, “Property
DerivativesforManagingEuropeanReal-EstateRisk,”receivedtheBestPaperAwardandhispaper
withthesamecoauthorsentitled“APricingFrameworkforRealEstateDerivatives”wasawarded
v
BestResearchPaperatthe10thResearchConferenceCampusforFinanceheldannuallyatWHU
OttoBeisheimSchoolofManagement,Vallendar,Germany.AnarticlecoauthoredwithDr.Sergio
Focardi,“AnAutoregressiveConditionalDurationModelofCreditRiskContagion,”publishedin
2005 inJournalofRiskFinancewas thewinner ofthe2006Outstanding PaperbyEmerald Literati
Network.
He has received several awards and honors for his body of work. In 1994 he was awarded an
Honorary Doctorate of Humane Letters from Nova Southeastern University. In 2002 he was in-
ducted into the Fixed Income Analysts Society’s Hall of Fame, established by the society “to rec-
ognizethelifetimeachievements ofoutstandingpractitionersintheadvancement oftheanalysis
offixed-incomesecuritiesandportfolios.”In2007hewastherecipientoftheC.StewartSheppard
AwardgivenbytheCFAInstitute“inrecognitionofoutstandingcontributiontocontinuingedu-
cationintheCFAprofession.”HewasthecoverstoryintheJuly1999issueofBloombergMagazine
entitled“TheBoswellofBonds.”
ProfessorFabozziwastheco-founderofInformationManagementNetwork(nowasubsidiaryof
Euromoney),aconferencecompanyspecializinginfinancialtopics.HeisatrusteefortheBlackRock
familyofclosed-endfundswhereheisthechairoftheperformancecommitteeandamemberof
theauditcommittee.HewasadirectorofGuardianMutualFundsandGuardianAnnuityFunds.
HeearnedbothanM.A.andB.A.ineconomicsandstatisticsinJune1970fromtheCityCollege
ofNewYorkandelectedtoPhiBetaKappain1969.HeearnedaPh.D.inEconomicsinSeptember
1972fromtheCityUniversityofNewYork.ProfessorFabozziholdstwoprofessionaldesignations:
CharteredFinancialAnalyst(1977)andCertifiedPublicAccountant(1982).
Contents
Contributors xi BondValuation 207
Preface xvii BasicsofBondValuation 209
GuidetotheEncyclopediaof RelativeValueAnalysisofFixed-Income
FinancialModels xxxiii Products 225
Index 569 YieldCurvesandValuationLattices 235
UsingtheLatticeModeltoValueBondswith
Volume I EmbeddedOptions,Floaters,Options,and
Caps/Floors 243
AssetAllocation 1 UnderstandingtheBuildingBlocksforOAS
Mean-VarianceModelforPortfolioSelection 3 Models 257
PrinciplesofOptimizationforPortfolio QuantitativeModelstoValueConvertible
Selection 21 Bonds 271
AssetAllocationandPortfolioConstruction QuantitativeApproachestoInflation-Indexed
TechniquesinDesigningthe Bonds 277
Performance-SeekingPortfolio 35
CreditRiskModeling 297
AssetPricingModels 47 AnIntroductiontoCreditRiskModels 299
GeneralPrinciplesofAssetPricing 49 DefaultCorrelationinIntensityModelsfor
CapitalAssetPricingModels 65 CreditRiskModeling 313
ModelingAssetPriceDynamics 79 StructuralModelsinCreditRiskModeling 341
ArbitragePricing:Finite-StateModels 99 ModelingPortfolioCreditRisk 361
ArbitragePricing:Continuous-State, SimulatingtheCreditLossDistribution 377
Continuous-TimeModels 121 ManagingCreditSpreadRiskUsingDuration
TimesSpread(DTS) 391
BayesianAnalysisandFinancial
CreditSpreadDecomposition 401
ModelingApplications 137
CreditDerivativesandHedgingCreditRisk 407
BasicPrinciplesofBayesianAnalysis 139
IntroductiontoBayesianInference 151 DerivativesValuation 421
BayesianLinearRegressionModel 163 No-ArbitragePriceRelationsforForwards,
BayesianEstimationofARCH-TypeVolatility Futures,andSwaps 423
Models 175 No-ArbitragePriceRelationsforOptions 437
BayesianTechniquesandtheBlack-Litterman IntroductiontoContingentClaimsAnalysis 457
Model 189 Black-ScholesOptionPricingModel 465
vii
viii Contents
PricingofFutures/ForwardsandOptions 477 ClassificationandRegressionTreesandTheir
PricingOptionsonInterestRateInstruments 489 UseinFinancialModeling 375
BasicsofCurrencyOptionPricingModels 507 ApplyingCointegrationtoProblemsin
CreditDefaultSwapValuation 525 Finance 383
ValuationofFixedIncomeTotalReturnSwaps 541 NonlinearityandNonlinearEconometric
PricingofVariance,Volatility,Covariance, ModelsinFinance 401
andCorrelationSwaps 545 RobustEstimatesofBetasandCorrelations 437
Modeling,Pricing,andRiskManagementof WorkingwithHigh-FrequencyData 449
AssetsandDerivativesinEnergyand
FinancialModelingPrinciples 465
Shipping 555
MilestonesinFinancialModeling 467
Volume II FromArttoFinancialModeling 479
BasicDataDescriptionforFinancialModeling
EquityModelsandValuation 1 andAnalysis 485
DividendDiscountModels 3 TimeSeriesConcepts,Representations,
DiscountedCashFlowMethodsforEquity andModels 501
Valuation 15 ExtractingRisk-NeutralDensityInformation
RelativeValuationMethodsforEquity fromOptionsMarketPrices 521
Analysis 33
FinancialStatementAnalysis 529
EquityAnalysisinaComplexMarket 47
FinancialStatements 531
EquityPortfolioSelectionModelsinPractice 61
FinancialRatioAnalysis 545
BasicsofQuantitativeEquityInvesting 89
Cash-FlowAnalysis 565
QuantitativeEquityPortfolioManagement 107
ForecastingStockReturns 121 FiniteMathematics forFinancial
Modeling 579
FactorModelsforPortfolio
ImportantFunctionsandTheirFeatures 581
Construction 135
TimeValueofMoney 595
FactorModels 137
FundamentalsofMatrixAlgebra 621
PrincipalComponentsAnalysisandFactor
DifferenceEquations 629
Analysis 153
DifferentialEquations 643
MultifactorEquityRiskModelsandTheir
PartialDifferentialEquationsinFinance 659
Applications 171
Factor-BasedEquityPortfolioConstruction ModelRiskandSelection 689
andAnalysis 195 ModelRisk 691
Cross-SectionalFactor-BasedModelsand ModelSelectionandItsPitfalls 699
TradingStrategies 213 ManagingtheModelRiskwiththeMethods
TheFundamentalsofFundamentalFactor oftheProbabilisticDecisionTheory 719
Models 243 Fat-TailedModelsforRiskEstimation 731
MultifactorEquityRiskModelsandTheir
Applications 255
MultifactorFixedIncomeRiskModelsand
Volume III
TheirApplications 267
FinancialEconometrics 293 Mortgage-BackedSecurities
ScopeandMethodsofFinancialEconometrics 295 AnalysisandValuation 1
RegressionAnalysis:TheoryandEstimation 305 ValuingMortgage-BackedandAsset-Backed
CategoricalandDummyVariablesin Securities 3
RegressionModels 333 TheActive-PassiveDecompositionModel
QuantileRegression 353 forMBS 17
ARCH/GARCHModelsinAppliedFinancial AnalysisofNonagencyMortgage-Backed
Econometrics 359 Securities 29