Statistical Tools for Finance and Insurance by Pavel Cizek, Wolfgang Karl Härdle, Rafal Weron

By Pavel Cizek, Wolfgang Karl Härdle, Rafal Weron

This booklet provides ready-to-use options, theoretical advancements and procedure development for plenty of sensible difficulties in quantitative finance and assurance. It bargains a special mixture of themes that might gain each industry analyst and danger manager.

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From a risk management perspective, beating the competition is difficult, because knowing exactly what the competition is doing, or even in some cases who they are, is difficult. Trying to beat the competition is like trying to manage against a benchmark without knowing its composition. Therefore, the relative risk is an unknown, and one cannot add a lot of value to an unknown. For a particular fund, we must also determine if risk is symmetrical. Distributions might be skewed because the fund has derivative positions, and even absent derivative exposure, certain markets, such as emerging markets, can create fat-tail distributions.

Indd 25 8/28/10 8:12:56 PM 26 Part I: Overview—1990–1999 data that are not actionable. Portfolio managers and the firm’s senior management—the “right people”—need data and information that they can act on, which is why and how the risk measurement group in an organization can add value. The “right time” is not always easy to identify, particularly when someone has to look at the pros and cons of different methodologies and different systems. The trade-off is frequently between accuracy and speed.

Because the hedge is being reduced as the portfolio rises and increased as the portfolio drops, the strategy essentially requires buying on the way up and selling on the way down. The result is a slippage or friction cost because the buying and selling happen in reaction to the price moves; that is, they occur slightly after the fact. The cumulative cost of this slippage can be computed mathematically using the tools of option-pricing theory; the cumulative cost of the slippage should be about the same as the cost of a put option with an exercise price equal to the hedge floor.

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