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Bayesian Methods in Finance

Svetlozar T. Rachev, John S. J. Hsu, Biliana S. Bagasheva, Frank J. Fabozzi

ISBN: 978-0-471-92083-0 February 2008 329 Pages


Bayesian Methods in Finance provides a detailed overview of the theory of Bayesian methods and explains their real-world applications to financial modeling. While the principles and concepts explained throughout the book can be used in financial modeling and decision making in general, the authors focus on portfolio management and market risk management—since these are the areas in finance where Bayesian methods have had the greatest penetration to date.

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Preface xv

About the Authors xvii

CHAPTER 1 Introduction 1

CHAPTER 2 The Bayesian Paradigm 6

CHAPTER 3 Prior and Posterior Information, Predictive Inference 22

CHAPTER 4 Bayesian Linear Regression Model 43

CHAPTER 5 Bayesian Numerical Computation 61

CHAPTER 6 Bayesian Framework For Portfolio Allocation 92

CHAPTER 7 Prior Beliefs and Asset Pricing Models 118

CHAPTER 8 The Black-Litterman Portfolio Selection Framework 141

CHAPTER 9 Market Efficiency and Return Predictability 162

CHAPTER 10 Volatility Models 185

CHAPTER 11 Bayesian Estimation of ARCH-Type Volatility Models 202

CHAPTER 12 Bayesian Estimation of Stochastic Volatility Models 229

CHAPTER 13 Advanced Techniques for Bayesian Portfolio Selection 247

CHAPTER 14 Multifactor Equity Risk Models 280

References 298

Index 311

  • Explains and illustrates the foundations of Bayesian analysis oriented to participants in the finance market. The use of Bayesian methods leads to better portfolio selection and estimation risk.  It also provides a very versatile framework to incorporate the prior views of a fund manager into the asset allocation process, and help users to decide on which explanatory variables to include in a model, through Bayesian variable selection techniques.
  • Provides applications to leading asset management models such as the Black-Litterman model and fundamental factor models.
  • Provides applications to corporate finance.  Includes real options, capital budgeting, dividend payout policy.