Description
At both theoretical and practical levels, finance theory has made extraordinary intellectual strides while contributing immensely to economic development. At the same time it has enriched the many financial engineers able to innovate and trade in financial products that create greater liquidity, predict and price assets, manage financial risks, and contribute to the growth of financial markets. Today, risk finance and engineering is confronted with immense challenges and opportunities. They include:
Bridging theory and practice following the important contributions made these past decades by Kenneth Arrow and Gerard Debreu’s fundamental theory of asset pricing and its many uses to better comprehend the working of financial markets and price assets and their derivatives.
Reconciling the doubts raised by assumptions of fundamental finance and opportunities to profit by the initiated who can appreciate the pro and cons of these theories.
The motivation for this book arose in the course of my lectures in the Department of Finance and Risk Engineering at the New York University (NYU) Polytechnic Institute following the financial meltdown of 2008–2009. This was a year when risks and all their financial manifestations struck at the heart of financial citadels and world economies. No firm was too big to fail, and risks hitherto conceived of theoretically, ignored, or only dreamed of have revealed their potency. This was also a year when extreme events have come into their own: ex ante ignored, but factual and painful ex post for all those who ignored the unlikely. The whole world was hurting: Unemployment, deflation of assets, and times of reckoning with greed, regulation, constraints, and finiteness of resources have become the underlying tune of financial discourse. Both persons and institutions have questioned the validity of financial models and their practical implications. On the academic front, challenging questions have been raised against the fundamental and complete markets dogma of finance, claiming that models can default and that incomplete markets are far more prevalent than theoretical finance would have us believe.
The financial meltdown of 2008–2009 has also ignited a far greater concern for the underlying purposes of finance, not only as a means to get rich but to confront the risks that beset us—whether predictable or not. These include population growth, environmental challenges, globalization of finance, infrastructure, wellness, and so on. These are real problems of common and personal importance. Financial transparency is called for to be part of the answer. The intent of this book is to provide an accessible formulation of theoretical financial constructs embedded in a broad variety of real and useful problems.