ENCYCLOPEDIA

OF
FINANCIAL MODELS
Volume II

FRANK J. FABOZZI, EDITOR

WILEY
John Wiley & Sons, Inc.
Contents

Contributors XI Bond Valuation 207

Preface xvii Basics of Bond Valuation 209
Guide to the Encyclopedia of Relative Value Analysis of Fixed-Income
Financial Models xxxiii Products 225
Index 757 Yield Curves and Valuation Lattices 235
Using the Lattice Model to Value Bonds with
Volume I Embedded Options, Floaters, Option, and
Caps/Floors • 243
Asset Allocation 1 Understanding the Building Blocks for OAS
Mean-Variance Model for Portfolio Selection 3 Models 257
Principles of Optimization for Portfolio Quantitative Models to Value Convertible
Selection 21 Bonds 271
Asset Allocation and Portfolio Construction Quantitative Approaches to Inflation-Indexed
Techniques in Designing the Bonds 277
Performance-Seeking Portfolio 35
Credit Risk Modeling 297
Asset Pricing Models 47 An Introduction to Credit Risk Models 299
General Principles of Asset Pricing 49 Default Correlation in Intensity Models for
Capital Asset Pricing Models 65 Credit Risk Modeling 313
Modeling Asset Price Dynamics 79 Structural Models in Credit Risk Modeling 341
Arbitrage Pricing: Finite-State Models 99 Modeling Portfolio Credit Risk 361
Arbitrage Pricing: Continuous-State, Simulating the Credit Loss Distribution 377
Continuous-Time Models 121 Managing Credit Spread Risk Using Duration
Times Spread (DTS) 391
Bayesian Analysis and Financial Credit Spread Decomposition 401
Modeling Applications 137 Credit Derivatives and Hedging Credit Risk 407
Basic Principles of Bayesian Analysis 139
Introduction to Bayesian Inference 151 Derivatives Valuation 421
Bayesian Linear Regression Model 163 No-Arbitrage Price Relations for Forwards,
Bayesian Estimation of ARCH-Type Volatility Futures, and Swaps 423
Models 175 No-Arbitrage Price Relations for Options 437
Bayesian Techniques and the Black-Litterman Introduction to Contingent Claims Analysis 457
Model 189 Black-Scholes Option Pricing Model 465

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viii Contents

Pricing of Futures/Forwards and Options 477 Classification and Regression Trees and Their
Pricing Options on Interest Rate Instruments 489 Use in Financial Modeling 375
Basics of Currency Option Pricing Models 507 Applying Cointegration to Problems in
Credit Default Swap Valuation 525 Finance 383
Valuation of Fixed Income Total Return Swaps 541 Nonlinearity and Nonlinear Econometric
Pricing of Variance, Volatility, Covariance, Models in Finance 401
and Correlation Swaps 545 Robust Estimates of Betas and Correlations 437
Modeling, Pricing, and Risk Management of Working with High-Frequency Data 449
Assets and Derivatives in Energy and
Shipping -— 555 Financial Modeling Principles 465
Milestones in Financial Modeling 467
From Art to Financial Modeling 479
Volume II Basic Data Description for Financial Modeling
Equity Models and Valuation 1 and Analysis 485
Dividend Discount Models 3 Time Series Concepts, Representations,
Discounted Cash Flow Methods for Equity and Models 501
Valuation 15 Extracting Risk-Neutral Density Information
Relative Valuation Methods for Equity from Options Market Prices 521
Analysis 33
Equity Analysis in a Complex Market 47
Financial Statement Analysis 529
Financial Statements 531
Equity Portfolio Selection Models in Practice 61
Financial Ratio Analysis 545
Basics of Quantitative Equity Investing 89
Cash-Flow Analysis 565
Quantitative Equity Portfolio Management 107
Forecasting Stock Returns 121 Finite Mathematics for Financial
Factor Models for Portfolio Modeling 579
Important Functions and Their Features 581
Construction 135 Time Value of Money 595
Factor Models 137
Fundamentals of Matrix Algebra 621,
Principal Components Analysis and Factor
Difference Equations 629
Analysis 153
Differential Equations 643
Multifactor Equity Risk Models and Their
Partial Differential Equations in Finance 659
Applications 171
Factor-Based Equity Portfolio Construction Model Risk and Selection 689
and Analysis \ 195 Model Risk 691
Cross-Sectional Factor-Based Models and Model Selection and Its Pitfalls 699
Trading Strategies 213 Managing the Model Risk with the Methods
The Fundamentals of Fundamental Factor of the Probabilistic Decision Theory 719
Models 243 Fat-Tailed Models for Risk Estimation 731
Multifactor Equity Risk Models and Their
Applications 255
Multifactor Fixed Income Risk Models and
Their Applications 267 Volume III
Financial Econometrics 293 Mortgage-Backed Securities
Scope and Methods of Financial Econometrics 295 Analysis and Valuation 1
Regression Analysis: Theory and Estimation 305 Valuing Mortgage-Backed and Asset-Backed
Categorical and Dummy Variables in Securities 3
Regression Models 333 The Active-Passive Decomposition Model
Quantile Regression 353 for MBS 17
ARCH /GARCH Models in Applied Financial Analysis of Nonagency Mortgage-Backed
Econometrics 359 Securities 29
 CONTENTS IX

Measurements of Prepayments for Back-Testing Market Risk Models 361

Residential Mortgage-Backed Securities 47 Estimating Liquidity Risks 371
Prepayments and Factors Influencing the Estimate of Downside Risk with Fat-Tailed
Return of Principal for Residential and Skewed Models 381
Mortgage-Backed Securities 65 Moving Average Models for Volatility and
Correlation, and Covariance Matrices 395
Operational Risk 79
Operational Risk 81 Software for Financial Modeling 415
Operational Risk Models 91 Introduction to Financial Model Building
Modeling Operational Loss Distributions 103 with MATLAB 417
Introduction to Visual Basic for Applications 449
Optimization Tools 121
Introduction to Stochastic Programming and Stochastic Processes and Tools 469
Its Applications to Finance 123 Stochastic Integrals 471
Robust Portfolio Optimization 137 Stochastic Differential Equations 485
Stochastic Processes in Continuous Time 495
Probability Theory 149 Conditional Expectation and Change of
Concepts of Probability Theory 151 Measure 507
Discrete Probability Distributions - 165 Change of Time Methods 519
Continuous Probability Distributions 195
Continuous Probability Distributions with Term Structure Modeling 531
Appealing Statistical Properties 207 The Concept and Measures of Interest Rate
Continuous Probability Distributions Dealing Volatility • 533
Short-Rate Term Structure Models 543
with Extreme Events 227
Static Term Structure Modeling in Discrete
Stable and Tempered Stable Distributions 241
Fat Tails, Scaling, and Stable Laws 259 and Continuous Time 559
The Dynamic Term Structure Model 575
Copulas 283
Essential Classes of Interest Rate Models and
Applications of Order Statistics to Risk
Management Problems 289 Their Use 593
A Review of No Arbitrage Interest Rate
Risk Measures 297 Models 603
Measuring Interest Rate Risk: Effective
Trading Cost Models 621
Duration and Convexity 299
Modeling Market Impact Costs 623
Yield Curve Risk Measures 307
Value-at-Risk 319 Volatility 635
Average Value-at-Risk 331 Monte Carlo Simulation in Finance 637
Risk Measures and Portfolio Selection 349 Stochastic Volatility 653