Simulation and Optimization in Finance: Modeling with MATLAB, @Risk, or VBA

Preface xi About the Authors xvi Acknowledgments xvii CHAPTER 1 Introduction 1 Optimization Simulation Outline of Topics PART ONE Fundamental Concepts CHAPTER 2 Important Finance Concepts 11 Basic Theory of Interest Asset Classes Basic Trading Terminology Calculating Rate of Return Valuation Important Concepts in Fixed Income Summary Notes CHAPTER 3 Random Variables, Probability Distributions, and Important Statistical Concepts 51 What is a Probability Distribution? Bernoulli Probability Distribution and Probability Mass Functions Binomial Probability Distribution and Discrete Distributions Normal Distribution and Probability Density Functions Concept of Cumulative Probability Describing Distributions Brief Overview of Some Important Probability Distributions Dependence Between Two Random Variables: Covariance and Correlation Sums of Random Variables Joint Probability Distributions and Conditional Probability From Probability Theory to Statistical Measurement: Probability Distributions and Sampling Summary Software Hints Notes CHAPTER 4 Simulation Modeling 101 Monte Carlo Simulation: A Simple Example Why Use Simulation? Important Questions in Simulation Modeling Random Number Generation Summary Software Hints Notes CHAPTER 5 Optimization Modeling 143 Optimization Formulations Important Types of Optimization Problems Optimization Problem Formulation Examples Optimization Algorithms Optimization Duality Multistage Optimization Optimization Software Summary Software Hints Notes CHAPTER 6 Optimization under Uncertainty 211 Dynamic Programming Stochastic Programming Robust Optimization Summary Notes PART TWO Portfolio Optimization and Risk Measures CHAPTER 7 Asset Diversification and Efficient Frontiers 245 The Case for Diversification The Classical Mean-Variance Optimization Framework Efficient Frontiers Alternative Formulations of the Classical Mean-Variance Optimization Problem The Capital Market Line Expected Utility Theory Summary Software Hints Notes CHAPTER 8 Advances in the Theory of Portfolio Risk Measures 277 Classes of Risk Measures Value-At-Risk Conditional Value-At-Risk and the Concept of Coherent Risk Measures Summary Software Hints Notes CHAPTER 9 Equity Portfolio Selection in Practice 321 The Investment Process Portfolio Constraints Commonly Used in Practice Benchmark Exposure and Tracking Error Minimization Incorporating Transaction Costs Incorporating Taxes Multiaccount Optimization Robust Parameter Estimation Portfolio Resampling Robust Portfolio Optimization Summary Software Hints Notes CHAPTER 10 Fixed Income Portfolio Management in Practice 373 Measuring Bond Portfolio Risk The Spectrum of Bond Portfolio Management Strategies Liability-Driven Strategies Summary Notes PART THREE Asset Pricing Models CHAPTER 11 Factor Models 401 The Capital Asset Pricing Model The Arbitrage Pricing Theory Building Multifactor Models in Practice Applications of Factor Models in Portfolio Management Summary Software Hints Notes CHAPTER 12 Modeling Asset Price Dynamics 421 Binomial Trees Arithmetic Random Walks Geometric Random Walks Mean Reversion Advanced Random Walk Models Stochastic Processes Summary Software Hints Notes PART FOUR Derivative Pricing and Use CHAPTER 13 Introduction to Derivatives 477 Basic Types of Derivatives Important Concepts for Derivative Pricing and Use Pricing Forwards and Futures Pricing Options Pricing Swaps Summary Software Hints Notes CHAPTER 14 Pricing Derivatives by Simulation 531 Computing Option Prices with Crude Monte Carlo Simulation Variance Reduction Techniques Quasirandom Number Sequences More Simulation Application Examples Summary Software Hints Notes CHAPTER 15 Structuring and Pricing Residential Mortgage-Backed Securities 587 Types of Asset-Backed Securities Mortgage-Backed Securities: Important Terminology Types of RMBS Structures Pricing RMBS by Simulation Using Simulation to Estimate Sensitivity of RMBS Prices to Different Factors Structuring RMBS Deals Using Dynamic Programming Summary Notes CHAPTER 16 Using Derivatives in Portfolio Management 627 Using Derivatives in Equity Portfolio Management Using Derivatives in Bond Portfolio Management Using Futures to Implement an Asset Allocation Decision Measuring Portfolio Risk When the Portfolio Contains Derivatives Summary Notes PART FIVE Capital Budgeting Decisions CHAPTER 17 Capital Budgeting under Uncertainty 653 Classifying Investment Projects Investment Decisions and Wealth Maximization Evaluating Project Risk Case Study Managing Portfolios of Projects Summary Software Hints Notes CHAPTER 18 Real Options 707 Types of Real Options Real Options and Financial Options New View of NPV Option to Expand Option to Abandon More Real Options Examples Estimation of Inputs for Real Option Valuation Models Summary Software Hints Notes References 733 Index 743