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Author of the acclaimed work Iceberg Risk: An Adventure in Portfolio Theory, Kent Osband argues that uncertainty is central rather than marginal to finance. Markets don't trade mainly on changes in risk. They trade on changes in beliefs about risk, and in the process, markets unite, stretch, and...
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Most portfolio risk analysis implicitly assumes that risks are stable, despite copious evidence of instability. This article presents an alternative, VarGamma, that provides neat formulas for certainty equivalents (risk-adjusted returns) even with stochastic volatility and volatility-dependent...
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When financial securities are modeled as claims on stochastic processes, each trader's beliefs at time can be summarized by a subjective probability distribution . The dominant Rational Expectations approach typically treats as a singleton that correctly gauges risks. In reality, financial risks...
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Since borrowers want minimal pressure to repay early while depositors want minimal constraints on withdrawals, banks typically borrow short to lend long. This is known as duration mismatch. To mitigate the risks, banks are required to hold capital buffers, which are intended to cover all losses...
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Credit grades are ordinal measures of default risk that are used to rank the relative creditworthiness of different borrowers rather than the relative safety of different environments. They are assigned by specialized rating agencies, which face short-term pressures to fudge their rankings and...
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Standard finance theory has long identified equity investment with aggregate consumption and equity investors with average consumers, while treating most growth risks as iid. The combination makes it impossible to reconcile high equity risk premia with modest risk aversion. Reinterpreting equity...
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