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Volatility and Correlation: The Perfect Hedger and the Fox (Wiley Finance)
By Riccardo Rebonato
Publisher: Wiley
Number Of Pages: 864
Publication Date: 2004-09-20
ISBN-10 / ASIN: 0470091398
ISBN-13 / EAN: 9780470091395
Binding: Hardcover
In Volatility and Correlation 2nd edition: The Perfect Hedger and the Fox, Rebonato looks at derivatives pricing from the angle of volatility and correlation. With both practical and theoretical applications, this is a thorough update of the highly successful Volatility Correlation â “ with over 80ew or fully reworked material and is a must have both for practitioners and for students.
The new and updated material includes a critical examination of the acirc; ˜perfect-replicationâ ™ approach to derivatives pricing, with special attention given to exotic options; a thorough analysis of the role of quadratic variation in derivatives pricing and hedging; a discussion of the informational efficiency of markets in commonly-used calibration and hedging practices. Treatment of new models including Variance Gamma, displaced diffusion, stochastic volatility for interest-rate smiles and equity/FX options.
The book is split into four parts. Part I deals with a Black world without smiles, sets out the authoracirc; ™s â ˜philosophicalâ ™ approach and covers deterministic volatility. Part II looks at smiles in equity and FX worlds. It begins with a review of relevant empirical information about smiles, and provides coverage of local-stochastic-volatility, general-stochastic-volatility, jump-diffusion and Variance-Gamma processes. Part II concludes with an important chapter that discusses if and to what extent one can dispense with an explicit specification of a model, and can directly prescribe the dynamics of the smile surface.
Part III focusses on interest rates when the volatility is deterministic. Part IV extends this setting in order to account for smiles in a financially motivated and computationally tractable manner. In this final part the author deals with CEV processes, with diffusive stochastic volatility and with Markov-chain processes.
Praise for the First Edition:
acirc; œIn this book, Dr Rebonato brings his penetrating eye to bear on option pricing and hedging.â ¦ The book is a must-read for those who already know the basics of options and are looking for an edge in applying the more sophisticated approaches that have recently been developed.â
acirc; ”Professor Ian Cooper, London Business School
acirc; œVolatility and correlation are at the very core of all option pricing and hedging. In this book, Riccardo Rebonato presents the subject in his characteristically elegant and simple fashionâ ¦A rare combination of intellectual insight and practical common sense.â
acirc; ”Anthony Neuberger, London Business School
Summary: Amazing book
Rating: 4
This is an extra-ordinary book by one of the best in the field. Very unique perspective on theory and practice of pricing and hedging. Wish it was bit less verbose though.
Summary: Excellent
Rating: 5
There are many books on financial modeling currently available and each has a different approach to presenting the subject matter. Some endeavor to present rigorous mathematical formalism and real-world practical examples are kept to a minimum or are completely absent. Others, and there are many of these, only sketch the mathematical details and present many (usually trivial) examples using software tools such as EXCEL or SAS. Then there are those books that attempt to explain in detail the intuition and meaning behind the concepts used in financial modeling, and never tire at giving readers the insight they need in order to become successful financial analysts/modelers. For reasons unknown, these books are rare, but when one comes across them they definitely stand apart from the others in terms of their high didactic quality. Reading these books is sheer pleasure, and no matter how high they are priced their readers are still getting a bargain.
This book is one of these, and readers who want a sound treatment of the mathematical theory of options along with insightful motivations behind this theory should reserve some time to study it. And it is a book that should be read not only by those who want to enter into the field of financial engineering, but also by seasoned professionals who need this kind of insight, if only to be able to better explain the underlying concepts to administrators and managers. It could also be very useful to instructors in the many financial engineering departments throughout the world. Hundreds of millions of dollars are devoted to financial modeling at the present time, and this is only likely to increase in the years to come, despite the pronouncements of some who are skeptical as to its value, pointing to the current strains in the credit markets as proof of its inefficacy.
Some examples of the clarity and insight that the author brings to his writing include the following:
* The discussion of the notion of a risk-neutral measure and the resulting Girsanov's theorem. This is a topic that is usually treated cavalierly in most books on financial modeling, but in this one the author motivates it in the context of the replication of option payoff. The side constraint `the absence of arbitrage' guarantees a unique price for option, and the author begins his motivation by considering the familiar approach via partial differential equations. But after this discussion he believes that arriving at and understanding Girsanov's theorem is best done outside of the continuous time framework, due to the latter's complexity. His ensuing discussion, done in the binomial approximation, proves its didactic power, for the author outlines four different approaches to the evaluation of the fair price of a contingent claim. The fourth one on risk-neutral valuation is the key to his explanation of Girsanov's theorem. Along the way, the Radon-Nikodym derivative appears, and in a way that is much more understandable than merely stating it as a definition, as it typically the case in books on real analysis. In this book it appears when one considers "switching numeraires" and the author does a beautiful job in explaining how this is connected with the equivalence of measures and Girsanov's theorem.
* More precise definitions of terms typically used in discussions on option pricing and general financial engineering and why this precision is necessary when engaging in financial modeling.
* The discussion on the difference between hedging with spot transactions in equity forward contracts versus interest-rate forward contracts. This discussion is generalized from forward contracts to options on equity or FX forwards, and gives insight into the difference between the "Black" world and the "Black-Scholes" world and the complexity of hedging with interest-rate derivatives.
* Detailed discussion and insights into the efficacy of hedging, in both the "real" and "risk-adjusted" contexts.
* The discussion on the Crouhy-Galai argument as to the need for including both the total variance and the instantaneous volatility in obtaining an optimal hedge.
Note: This review is based on a reading of four chapters of the book.
Summary: Very good but missing little things here and there
Rating: 3
Although the author warns the reader in the Preface, that because he ran out of pages (come on it is more than 800!) he omited dealing with Copulas, it is still a pitty that a book about correlation does not present at least a small chapter on this new (state-of-the-art) area.
Everything else is very good, solid material with a good balance between maths surrounding the topic, explanations and worked out examples.
Summary: very informative and reader friendly
Rating: 5
for the first time I really understood risk neutral probability, explanations are excellent. unfortunately I am only read about 10 chapters int he book, should spend more time with it.
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