The Best of Wilmott 1

NOVEMBER 11^TH 2003 saw a landmark event take place in London. As the first conference designed for quants by quants, the Quantitative Finance Review 2003 moved away from the anonymous bazaars that have become the norm, and instead delivered valuable information to market practitioners with the greatest interest. The roster of speakers was phenomenal, ranging from founding fathers to bright young things, discussing the latest developments, with a specific emphasis on the burgeoning field of credit derivatives. You really had to be there. Until now, at least.

The Best of Wilmott 1: Incorporating the Quantitative Finance Review 2003 contains these first-class articles, originally presented at the QFR 2003, along with a collection of selected technical papers from Wilmott magazine. In publishing this book we hope to share some of the great insights that, until now, only delegates at QFR 2003 were privy to, and give you some idea why Wilmott magazine is the most talked about periodical in the market.

Including articles from luminaries such as Ed Thorp, Jean-Philippe Bouchaud, Philipp Schoenbucher, Pat Hagan, Ephraim Clark, Marc Potters, Peter Jaeckel and Paul Wilmott, this collection is a must for anyone working in the field of quantitative finance. The articles cover a wide range of topics:

• Psychology in Financial Markets
• Measuring Country Risk as Implied Volatility
• The Equity-to-Credit Problem
• Introducing Variety in Risk Management
• The Art and Science of Curve Building
• Next Generation Models for Convertible Bonds with Credit Risk
• Stochastic Volatility and Mean-variance Analysis
• Cliquet Options and Volatility Models

And as they say at the end of (most) Bond movies The Best of Wilmott. . . will return on an annual basis.

Introduction ix
Paul Wilmott

I Education in Quantitative Finance 1
Riaz Ahmad

II Financialcad® 5
Owen Walsh

III Quantitative Finance Review 2003 7
Dan Tudball

Chapter 1 Rewind 11
Dan Tudball

Chapter 2 In for the Count 19
Dan Tudball

Chapter 3 A Perspective on Quantitative Finance: Models for Beating the Market 33
Ed Thorp

Chapter 4 Psychology in Financial Markets 39
Henriëtte Prast

Chapter 5 Credit Risk Appraisal: From the Firm Structural Approach to Modern Probabilistic Methodologies 59
Hugues E. Pirotte Spéder

Chapter 6 Modelling and Measuring Sovereign Credit Risk 69
Ephraim Clark

Chapter 7 The Equity-to-credit Problem (or the Story of Calibration, Co-calibration and Re-calibration) 79
Elie Ayache

Chapter 8 Measuring Country Risk as Implied Volatility 109
Ephraim Clark

Chapter 9 Next Generation Models for Convertible Bonds with Credit Risk 117
E.Ayache,P.A.ForsythandK.R.Vetzal

Chapter 10 First to Default Swaps 135
Antony Penaud and James Selfe

Chapter 11 Taken to the Limit: Simple and Not-so-simple Loan Loss Distributions 143
Philipp J. Schönbucher

Chapter 12 Sovereign Debt Default Risk: Quantifying the (Un)Willingness to Pay 161
Ephraim Clark

Chapter 13 Chord of Association 167
Aaron Brown

Chapter 14 Introducing Variety in Risk Management 181
Fabrizio Lillo, Rosario N. Mantegna, Jean-Philippe Bouchaud and Marc Potters

Chapter 15 Alternative Large Risks Hedging Strategies for Options 191
F. Selmi and Jean-Philippe Bouchaud

Chapter 16 On Exercising American Options: The Risk of Making More Money than You Expected 199
Hyungsok Ahn and Paul Wilmott

Chapter 17 Phi-alpha Optimal Portfolios and Extreme Risk Management 223
R. Douglas Martin, Svetlozar (Zari) Rachev, and Frederic Siboulet

Chapter 18 Managing Smile Risk 249
Patrick S. Hagan, Deep Kumar, Andrew S. Lesniewski and Diana E. Woodward

Chapter 19 Adjusters: Turning Good Prices into Great Prices 297
Patrick S. Hagan

Chapter 20 Convexity Conundrums: Pricing CMS Swaps, Caps, and Floors 305
Patrick S. Hagan

Chapter 21 Mind the Cap 319
Peter Jäckel

Chapter 22 The Art and Science of Curve Building 349
Owen Walsh

Chapter 23 Stochastic Volatility Models: Past, Present and Future 355
Peter Jäckel

Chapter 24 Cliquet Options and Volatility Models 379
Paul Wilmott

Chapter 25 Long Memory and Regime Shifts in Asset Volatility 391
Jonathan Kinlay

Chapter 26 Heston’s Stochastic Volatility Model: Implementation, Calibration and Some Extensions 401
Sergei Mikhailov and Ulrich Nögel

Chapter 27 Forward-start Options in Stochastic Volatility Models 413
Vladimir Lucic

Chapter 28 Stochastic Volatility and Mean-variance Analysis 421
Hyungsok Ahn and Paul Wilmott

Index 435

Dr Paul Wilmott has been described by the Financial Times as ‘the cult derivatives lecturer’.

He has for many years been a financial consultant specializing in derivatives, risk management and quantitative finance. He is the author of the best-selling Paul Wilmott Introduces Quantitative Finance (Wiley 2000) and Paul Wilmott on Quantitative Finance (Wiley 2001). He has written over 100 research articles on finance and mathematics.

Dr Wilmott runs www.wilmott.com, the popular quantitative finance community website, the quant magazine Wilmott, and is the Course Director for the Certificate in Quantitative Finance, www.7city.com/cqf.

Paul Wilmott is a partner in a statistical arbitrage hedge fund.

NOVEMBER 11^TH 2003 saw a landmark event take place in London. As the first conference designed for quants by quants, the Quantitative Finance Review 2003 moved away from the anonymous bazaars that have become the norm, and instead delivered valuable information to market practitioners with the greatest interest. The roster of speakers was phenomenal, ranging from founding fathers to bright young things, discussing the latest developments, with a specific emphasis on the burgeoning field of credit derivatives. You really had to be there. Until now, at least.

The Best of Wilmott 1: Incorporating the Quantitative Finance Review 2003 contains these first-class articles, originally presented at the QFR 2003, along with a collection of selected technical papers from Wilmott magazine. In publishing this book we hope to share some of the great insights that, until now, only delegates at QFR 2003 were privy to, and give you some idea why Wilmott magazine is the most talked about periodical in the market.

Including articles from luminaries such as Ed Thorp, Jean-Philippe Bouchaud, Philipp Schoenbucher, Pat Hagan, Ephraim Clark, Marc Potters, Peter Jaeckel and Paul Wilmott, this collection is a must for anyone working in the field of quantitative finance. The articles cover a wide range of topics:

• Psychology in Financial Markets
• Measuring Country Risk as Implied Volatility
• The Equity-to-Credit Problem
• Introducing Variety in Risk Management
• The Art and Science of Curve Building
• Next Generation Models for Convertible Bonds with Credit Risk
• Stochastic Volatility and Mean-variance Analysis
• Cliquet Options and Volatility Models

And as they say at the end of (most) Bond movies The Best of Wilmott. . . will return on an annual basis.