For all the supposed sophistication and accuracy of quantitative risk models, one key question continues to haunt portfolio managers. Why are stock market crashes and other market outliers so much more frequent than standard portfolio theory predicts?
The answer is dismayingly simple. Standard theory is so wedded to normal "bell-shaped" risks that it assumes the outliers away. This simplifies calculations and makes for innocuous auditors' reports. But the approach is fundamentally flawed. With a few exceptions, it can't capture the risks that large chunks of your portfolio soar or dive together.
Iceberg Risk exposes this crucial limitation through an engaging mixture of story, charts and math. Statistical concepts are developed intuitively first, and all algebra is cordoned off into neatly organized and digestible nuggets. The results will appeal to students of risk analysis and seasoned practitioners alike; indeed to anyone willing to question orthodox portfolio theory.
But merely understanding the problem is not sufficient. Iceberg Risk goes further. The second half is devoted to rebuilding portfolio theory on stronger foundations. The new theory is consistent with both economic rationality and common sense, in that (unlike some rival approaches) it never willingly favors sucker bets. It is flexible enough to handle virtually any kind of risk and any kind of asset, including options.
The new approach is also tractable. Answers can be calculated quickly using ordinary computer spreadsheets. And they are easily expressed in terms of risk-adjusted returns, the -metric by which portfolio performance ought to be judged. {‘Natural’ doesn’t fit with the qualifier. Actually I like the following version better::" the natural metric for judging portfolio performance though all too seldom used.",
Iceberg Risk takes the reader on a journey of discovery in risk management, starting where Markowitz and Sharpe leave off, and culminating in a new way to think about portfolio theory.
PART ONE: Standards of Deviation: Missing the Iceberg for the Ice Cubes
1. Odd Odds of Odds
2. New Angles on Pascal’s Triangle
3. Amazing Tails of Risk
4. More Amazing Tails
5. The Creation of Correlation
6. Defining Moments from De Finetti
7. Big Risks in Value at Risk
8. Good Approximations Behaving Badly
9. The Abnormality of Normality
10. Dependent Independence
11. Just Desserts
PART TWO: Insights into Ignorance : "More Dollars than Sense"
12. Teaching Elephants to Dance
13. Betting on Beta
14. Relief through Beliefs
15. Rating Risks without Regret
16. Unusually Useful Utility
17. Optimal Overlays
18. Adjusted Advice
19. Higher-Order High Jinks
20. A Question of Rebalance
21. Weighing the Options
22. Fixing the Focus
23. The Rooster Principle
About Kent Osband
Kent Osband combines academic, public policy and Wall Street expertise. He graduated magna cum laude from Harvard and received an economics PhD from UC Berkeley. He has taught at Harvard and UCLA and has published a dozen scholarly papers. For eight years he advised on Soviet and post-Soviet economic reform at the Rand Corporation, the IMF and the World Bank.
After moving to Wall Street in 1994 he served as international economist at Goldman Sachs, senior emerging markets strategist at Credit Suisse First Boston and co-manager of a top-rated global bond fund for CI Funds of Toronto. He currently heads quantitative trading and risk management for Drawbridge Global Macro Fund in New York.
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