Encyclopedia of Financial Models, Volume I

VOLUME I

The need for serious coverage of financial modeling has never been greater, especially with the size, diversity, and efficiency of modern capital markets. With this in mind, the Encyclopedia of Financial Models, 3 Volume Set has been created to help a broad spectrum of individuals ranging from finance professionals to academics and students understand the various models currently available and apply them in real–world situations.

Edited by Frank Fabozzi, this set includes contributions from global financial experts as well as academics with extensive consulting experience in this field. Incorporating timely research and in–depth analysis, Volume I of the Encyclopedia of Financial Models covers:

Asset Allocation Asset Pricing Models Bayesian Analysis and Financial Modeling Applications Bond Valuation Credit Risk Modeling Derivatives Valuation

Contributors xi

Preface xvii

Guide to the Encyclopedia of Financial Models xxxiii

Index 569

Volume I

Asset Allocation 1

Mean–Variance Model for Portfolio Selection 3

Principles of Optimization for Portfolio Selection 21

Asset Allocation and Portfolio Construction Techniques in Designing the Performance–Seeking Portfolio 35

Asset Pricing Models 47

General Principles of Asset Pricing 49

Capital Asset Pricing Models 65

Modeling Asset Price Dynamics 79

Arbitrage Pricing: Finite–State Models 99

Arbitrage Pricing: Continuous–State, Continuous–Time Models 121

Bayesian Analysis and Financial Modeling Applications 137

Basic Principles of Bayesian Analysis 139

Introduction to Bayesian Inference 151

Bayesian Linear Regression Model 163

Bayesian Estimation of ARCH–Type Volatility Models 175

Bayesian Techniques and the Black–Litterman Model 189

Bond Valuation 207

Basics of Bond Valuation 209

Relative Value Analysis of Fixed–Income Products 225

Yield Curves and Valuation Lattices 235

Using the Lattice Model to Value Bonds with Embedded Options, Floaters, Options, and Caps/Floors 243

Understanding the Building Blocks for OAS Models 257

Quantitative Models to Value Convertible Bonds 271

Quantitative Approaches to Inflation–Indexed Bonds 277

Credit Risk Modeling 297

An Introduction to Credit Risk Models 299

Default Correlation in Intensity Models for Credit Risk Modeling 313

Structural Models in Credit Risk Modeling 341

Modeling Portfolio Credit Risk 361

Simulating the Credit Loss Distribution 377

Managing Credit Spread Risk Using Duration Times Spread (DTS) 391

Credit Spread Decomposition 401

Credit Derivatives and Hedging Credit Risk 407

Derivatives Valuation 421

No–Arbitrage Price Relations for Forwards, Futures, and Swaps 423

No–Arbitrage Price Relations for Options 437

Introduction to Contingent Claims Analysis 457

Black–Scholes Option Pricing Model 465

Pricing of Futures/Forwards and Options 477

Pricing Options on Interest Rate Instruments 489

Basics of Currency Option Pricing Models 507

Credit Default Swap Valuation 525

Valuation of Fixed Income Total Return Swaps 541

Pricing of Variance, Volatility, Covariance, and Correlation Swaps 545

Modeling, Pricing, and Risk Management of Assets and Derivatives in Energy and Shipping 555