Advanced Analytical Models: Over 800 Models and 300 Applications from the Basel II Accord to Wall Street and BeyondISBN: 9780470179215
1014 pages
May 2008

Description
Table of Contents
Preface xv
Software Applications xvii
PART 1 Modeling Toolkit and Risk Simulator Applications 1
Introduction to the Modeling Toolkit Software 1
Introduction to Risk Simulator 2
Running a Monte Carlo Simulation 6
Using Forecast Charts and Confidence Intervals 16
Correlations and Precision Control 18
Tornado and Sensitivity Tools in Simulation 22
Sensitivity Analysis 29
Distributional Fitting: Single Variable and Multiple Variables 33
Bootstrap Simulation 35
Hypothesis Testing 40
Data Extraction, Saving Simulation Results, and Generating Reports 42
Regression and Forecasting Diagnostic Tool 42
Statistical Analysis Tool 52
Distributional Analysis Tool 54
Portfolio Optimization 56
Optimization with Discrete Integer Variables 70
Forecasting 72
1. Analytics—Central Limit Theorem 79
2. Analytics—Central Limit Theorem—Winning Lottery Numbers 84
3. Analytics—Flaw of Averages 88
4. Analytics—Mathematical Integration Approximation Model 93
5. Analytics—Projectile Motion 96
6. Analytics—Regression Diagnostics 100
7. Analytics—Ships in the Night 109
8. Analytics—Statistical Analysis 111
9. Analytics—Weighting of Ratios 123
10. Credit Analysis—Credit Premium 125
11. Credit Analysis—Credit Default Swaps and Credit Spread Options 127
12. Credit Analysis—Credit Risk Analysis and Effects on Prices 129
13. Credit Analysis—External Debt Ratings and Spread 131
14. Credit Analysis—Internal Credit Risk Rating Model 133
15. Credit Analysis—Profit Cost Analysis of New Credit 135
16. Debt Analysis—AssetEquity Parity Model 137
17. Debt Analysis—Cox Model on Price and Yield of Risky Debt with MeanReverting Rates 138
18. Debt Analysis—Debt Repayment and Amortization 141
19. Debt Analysis—Debt Sensitivity Models 145
20. Debt Analysis—Merton Price of Risky Debt with Stochastic Asset and Interest 147
21. Debt Analysis—Vasicek Debt Option Valuation 149
22. Debt Analysis—Vasicek Price and Yield of Risky Debt 151
23. Decision Analysis—Decision Tree Basics 153
24. Decision Analysis—Decision Tree with EVPI, Minimax, and Bayes’ Theorem 158
25. Decision Analysis—Economic Order Quantity and Inventory Reorder Point 169
26. Decision Analysis—Economic Order Quantity and Optimal Manufacturing 170
27. Decision Analysis—Expected Utility Analysis 172
28. Decision Analysis—Inventory Control 174
29. Decision Analysis—Queuing Models 176
30. Exotic Options—Accruals on Basket of Assets 178
31. Exotic Options—American, Bermudan, and European Options with Sensitivities 180
32. Exotic Options—American Call Option on Foreign Exchange 182
33. Exotic Options—American Call Options on Index Futures 184
34. Exotic Options—American Call Option with Dividends 186
35. Exotic Options—Asian Lookback Options Using Arithmetic Averages 188
36. Exotic Options—Asian Lookback Options Using Geometric Averages 189
37. Exotic Options—Asset or Nothing Options 190
38. Exotic Options—Barrier Options 191
39. Exotic Options—Binary Digital Options 193
40. Exotic Options—Cash or Nothing Options 195
41. Exotic Options—Chooser Option (Simple Chooser) 196
42. Exotic Options—Chooser Option (Complex Chooser) 197
43. Exotic Options—Commodity Options 198
44. Exotic Options—Currency (Foreign Exchange) Options 199
45. Exotic Options—Double Barrier Options 200
46. Exotic Options—European Call Option with Dividends 201
47. Exotic Options—Exchange Assets Option 203
48. Exotic Options—Extreme Spreads Option 204
49. Exotic Options—Foreign Equity–Linked Foreign Exchange Options in Domestic Currency 205
50. Exotic Options—Foreign Equity Struck in Domestic Currency 207
51. Exotic Options—Foreign Equity with Fixed Exchange Rate 208
52. Exotic Options—Foreign Takeover Options 209
53. Exotic Options—Forward Start Options 210
54. Exotic Options—Futures and Forward Options 211
55. Exotic Options—Gap Options 212
56. Exotic Options—Graduated Barrier Options 213
57. Exotic Options—Index Options 214
58. Exotic Options—Inverse Gamma OutoftheMoney Options 215
59. Exotic Options—JumpDiffusion Options 216
60. Exotic Options—Leptokurtic and Skewed Options 217
61. Exotic Options—Lookback with Fixed Strike (Partial Time) 218
62. Exotic Options—Lookback with Fixed Strike 219
63. Exotic Options—Lookback with Floating Strike (Partial Time) 220
64. Exotic Options—Lookback with Floating Strike 221
65. Exotic Options—Min and Max of Two Assets 222
66. Exotic Options—Options on Options 223
67. Exotic Options—Option Collar 224
68. Exotic Options—Perpetual Options 225
69. Exotic Options—Range Accruals (Fairway Options) 226
70. Exotic Options—Simple Chooser 228
71. Exotic Options—Spread on Futures 229
72. Exotic Options—Supershare Options 230
73. Exotic Options—Time Switch Options 231
74. Exotic Options—TradingDay Corrections 232
75. Exotic Options—TwoAsset Barrier Options 233
76. Exotic Options—Two Asset Cash or Nothing 234
77. Exotic Options—Two Correlated Assets Option 235
78. Exotic Options—Uneven Dividend Payments Option 237
79. Exotic Options—Writer Extendible Option 238
80. Forecasting—Data Diagnostics 239
81. Forecasting—Econometric, Correlations, and Multiple Regression Modeling 248
82. Forecasting—Exponential JGrowth Curves 254
83. Forecasting—Forecasting Manual Computations 257
84. Forecasting—Linear Interpolation and Nonlinear Spline Extrapolation 259
85. Forecasting—Logistic SGrowth Curves 264
86. Forecasting—Markov Chains and Market Share 267
87. Forecasting—Multiple Regression 269
88. Forecasting—Nonlinear Extrapolation and Forecasting 271
89. Forecasting—Stochastic Processes, Brownian Motion, Forecast Distribution at Horizon, JumpDiffusion, and MeanReversion 273
90. Forecasting—TimeSeries ARIMA 276
91. Forecasting—TimeSeries Analysis 283
92. Industry Applications—Biotech Manufacturing Strategy 287
93. Industry Applications—Biotech Inlicensing Drug Deal Structuring 289
94. Industry Applications—Biotech Investment Valuation 291
95. Industry Application—Banking: Integrated Risk Management, Probability of Default, Economic Capital,
Value at Risk, and Optimal Bank Portfolios 293
96. Industry Application—Electric/Utility: Optimal Power Contract Portfolios 321
97. Industry Application—IT—Information Security Intrusion Risk Management 329
98. Industry Applications—Insurance ALM Model 349
99. Operational Risk—Queuing Models at Bank Branches 354
100. Optimization—Continuous Portfolio Allocation 356
101. Optimization—Discrete Project Selection 362
102. Optimization—Inventory Optimization 366
103. Optimization—Investment Portfolio Allocation 372
104. Optimization—Investment Capital Allocation I (Basic Model) 373
105. Optimization—Investment Capital Allocation II (Advanced Model) 376
106. Optimization—Military Portfolio and Efficient Frontier 380
107. Optimization—Optimal Pricing with Elasticity 386
108. Optimization—Optimization of a Harvest Model 390
109. Optimization—Optimizing Ordinary Least Squares 394
110. Optimization—Stochastic Portfolio Allocation 400
111. Options Analysis—Binary Digital Instruments 405
112. Options Analysis—Inverse Floater Bond 407
113. Options Analysis—OptionsTrading Strategies 413
114. Options Analysis—OptionsAdjusted Spreads Lattice 420
115. Options Analysis—Options on Debt 422
116. Options Analysis—Five Plain Vanilla Options 424
117. Probability of Default—Bond Yields and Spreads (Market Comparable) 432
118. Probability of Default—Empirical Model 434
119. Probability of Default—External Options Model (Public Company) 437
120. Probability of Default—Merton Internal Options Model (Private Company) 441
121. Probability of Default—Merton Market Options Model (Industry Comparable) 442
122. Project Management—Cost Estimation Model 443
123. Project Management—Critical Path Analysis (CPM PERT GANTT) 446
124. Project Management—Project Timing 453
125. Real Estate—Commercial Real Estate ROI 456
126. Risk Analysis—Integrated Risk Analysis 460
127. Risk Analysis—Interest Rate Risk 472
128. Risk Analysis—Portfolio Risk Return Profiles 474
129. Risk Hedging—DeltaGamma Hedging 477
130. Risk Hedging—Delta Hedging 478
131. Risk Hedging—Effects of Fixed versus Floating Rates 479
132. Risk Hedging—Foreign Exchange Cash Flow Model 481
133. Risk Hedging—Hedging Foreign Exchange Exposure 487
134. Sensitivity—Greeks 491
135. Sensitivity—Tornado and Sensitivity Charts Linear 496
136. Sensitivity—Tornado and Sensitivity Nonlinear 503
137. Simulation—Basic Simulation Model 510
138. Simulation—Best Surgical Team 517
139. Simulation—Correlated Simulation 525
140. Simulation—Correlation Effects on Risk 528
141. Simulation—Data Fitting 531
142. Simulation—Debt Repayment and Amortization 534
143. Simulation—Demand Curve and Elasticity Estimation 538
144. Simulation—Discounted Cash Flow, Return on Investment, and Volatility Estimates 542
145. Simulation—Infectious Diseases 546
146. Simulation—Recruitment Budget (Negative Binomial and Multidimensional Simulation) 548
147. Simulation—Retirement Funding with VBA Macros 556
148. Simulation—Roulette Wheel 560
149. Simulation—Time Value of Money 562
150. Six Sigma—Obtaining Statistical Probabilities, Basic Hypothesis Tests, Confidence Intervals, and Bootstrapping Statistics 571
151. Six Sigma—One and TwoSample Hypothesis Tests Using tTests, ZTests, FTests, ANOVA, and Nonparametric Tests (Friedman, Kruskal Wallis, Lilliefors, and Runs Tests) 590
152. Six Sigma—Sample Size Determination and Design of Experiments 623
153. Six Sigma—Statistical and Unit Capability Measures, Specification Levels, and Control Charts 627
154. Valuation—Buy versus Lease 631
155. Valuation—Banking: Classified Loan Borrowing Base 634
156. Valuation—Banking: BreakEven Inventory with Seasonal Lending Trial Balance Analysis 637
157. Valuation—Banking: Firm in Financial Distress 640
158. Valuation—Banking: Pricing Loan Fees Model 642
159. Valuation—Valuation Model 644
160. Value at Risk—Optimized and Simulated Portfolio VaR 647
161. Value at Risk—Options Delta Portfolio VaR 651
162. Value at Risk—Portfolio Operational and Credit Risk VaR Capital Adequacy 653
163. Value at Risk—RightTail Capital Requirements 657
164. Value at Risk—Static Covariance Method 661
165. Volatility—Implied Volatility 663
166. Volatility—Volatility Computations (Log Returns, Log Assets, Implied Volatility, Management Assumptions, EWMA, GARCH) 664
167. Yield Curve—CIR Model 673
168. Yield Curve—Curve Interpolation BIM Model 674
169. Yield Curve—Curve Interpolation NS Model 676
170. Yield Curve—Forward Rates from Spot Rates 678
171. Yield Curve—Term Structure of Volatility 679
172. Yield Curve—U.S. Treasury RiskFree Rates and Cubic Spline Curves 680
173. Yield Curve—Vasicek Model 690
PART 2 Real Options SLS Applications 693
174. Introduction to the SLS Software 695
Single Asset and Single Phased Module 697
Multiple Asset or Multiple Phased SLS Module 704
Multinomial SLS Module 705
SLS Excel Solution Module 709
SLS Excel Functions Module 712
Lattice Maker Module 714
175. Employee Stock Options—Simple American Call Option 715
176. Employee Stock Options—Simple Bermudan Call Option with Vesting 716
177. Employee Stock Options—Simple European Call Option 719
178. Employee Stock Options—Suboptimal Exercise 720
179. Employee Stock Options—Vesting, Blackout, Suboptimal, Forfeiture 723
180. Exotic Options—American and European Lower Barrier Options 725
181. Exotic Options—American and European Upper Barrier Options 728
182. Exotic Options—American and European Double Barrier Options and Exotic Barriers 731
183. Exotic Options—Basic American, European, and Bermudan Call Options 734
184. Exotic Options—Basic American, European, and Bermudan Put Options 736
185. Real Options—American, European, Bermudan, and Customized Abandonment Options 739
186. Real Options—American, European, Bermudan, and Customized Contraction Options 749
187. Real Options—American, European, Bermudan, and Customized Expansion Options 756
188. Real Options—Contraction, Expansion, and Abandonment Options 763
189. Real Options—Dual Variable Rainbow Option Using Pentanomial Lattices 767
190. Real Options—Exotic Chooser Options 770
191. Real Options—Exotic Complex Floating American and European Chooser 771
192. Real Options—JumpDiffusion Option Using Quadranomial Lattices 774
193. Real Options—MeanReverting Calls and Puts Using Trinomial Lattices 777
194. Real Options—Multiple Assets Competing Options 779
195. Real Options—PathDependent, PathIndependent, Mutually Exclusive, Non–Mutually Exclusive, and
Complex Combinatorial Nested Options 781
196. Real Options—Sequential Compound Options 783
197. Real Options—Simultaneous Compound Options 791
198. Real Options—Simple Calls and Puts Using Trinomial Lattices 795
PART 3 Real Options Strategic Case Studies—Framing the Options 799
199. Real Options Strategic Cases—HighTech Manufacturing: Build or Buy Decision with Real Options 801
200. Real Options Strategic Cases—Oil and Gas: FarmOuts, Options to Defer, and Value of Information 810
201. Real Options Strategic Cases—Pharmaceutical Development: Value of Perfect Information and Optimal
Trigger Values 814
202. Real Options Strategic Cases—Option to Switch Inputs 817
203. Valuation—Convertible Warrants with a Vesting Period and Put Protection 821
APPENDIX A List of Models 827
APPENDIX B List of Functions 837
APPENDIX C Understanding and Choosing the Right Probability Distributions 899
APPENDIX D Financial Statement Analysis 919
APPENDIX E Exotic Options Formulae 927
APPENDIX F Measures of Risk 941
APPENDIX G Mathematical Structures of Stochastic Processes 957
Glossary of Input Variables and Parameters in the Modeling Toolkit Software 963
About the DVD 995
About the Author 999
Index 1001