Acknowledgments xi
Chapter 1 What This Book Is and Why You Should Read It 1
Risk, Danger, and Opportunity 2
Red- Blooded Risk Management 4
Risk and Life 7
Play and Money 9
Frequentism 11
Rationality 13
Bets 15
Exponentials and Culture 18
Payoff 20
Chapter 2 Red Blood and Blue Blood 23
Chapter 3 Pascal’s Wager and the Seven Principles of Risk Management 29
Principle I: Risk Duality 32
Principle II: Valuable Boundary 33
Principle III: Risk Ignition 35
Principle IV: Money 38
Outside the VaR Boundary 40
Principle V: Evolution 45
Principle VI: Superposition 48
Principle VII: Game Theory 49
Chapter 4 The Secret History of Wall Street: 1654– 1982 57
Pascal and Fermat 58
Poker 61
Advantage Gamblers 62
Sports Betting 63
Quants to Wall Street 66
Finance People 68
Real Finance 69
Chapter 5 When Harry Met Kelly 73
Kelly 74
Harry 76
Commodity Futures 79
If Harry Knew Kelly 84
Investment Growth Theory 88
eRaider.com 92
MPT Out in the World 96
Chapter 6 Exponentials, Vampires, Zombies, and Tulips 101
Types of Growth 102
The Negative Side 105
Tulips 106
Tulip Propaganda 108
Quantitative Tulip Modeling 111
Money 112
Chapter 7 Money 117
Chapter 8 The Story of Money: The Past 125
Property, Exchange, and Money 126
Paleonomics 128
Transition 131
What Money Does 134
Risk 135
Government and Paper 138
Paper versus Metal 142
1776 and All That 145
Andrew Dexter 147
A Short Digression into Politics and Religion 150
Chapter 9 The Secret History of Wall Street: 1983– 1987 155
Efficient Markets 157
Anomalies 159
The Price Is Right Not! 161
Efficiency versus Equilibrium 162
Beating the Market 165
Paths 170
Sharpe Ratios and Wealth 174
1987 177
Chapter 10 The Story of Money: The Future 179
Farmers and Millers 180
Money, New and Improved 183
A General Theory of Money 185
Value and Money 189
Numeraire 191
Clearinghouses 196
Cash 197
Derivative Money 200
The End of Paper 203
Chapter 11 Cold Blood 207
Chapter 12 What Does a Risk Manager Do?—Inside VaR 213
Professional Standards 213
Front Office 215
Trading Risk 217
Quants on the Job 218
Middle Office 222
Back Office 225
Middle Office Again 227
Looking Backward 228
Risk Control 230
Beyond Profit and Loss 232
Numbers 234
The Banks of the Charles 236
Waste 238
The Banks of the Potomac 241
The Summer of My Discontent 245
Validation 247
Chapter 13 VaR of the Jungle 251
Chapter 14 The Secret History of Wall Street: 1988– 1992 255
Smile 256
Back to the Dissertation 258
Three Paths 262
An Unexpected Twist 265
Surprise! 267
Computing VaR 271
Chapter 15 Hot Blood and Thin Blood 277
Chapter 16 What Does a Risk Manager Do?— Outside VaR 283
Stress Tests 283
Trans-VaR Scenarios 287
Black Holes 289
Why Risk Managers Failed to Prevent the Financial Crisis 290
Managing Risk 296
Unspeakable Truth Number One: Risk Managers Should Make Sure Firms Fail 299
Unspeakable Truth Number Two: There’s Good Stuff beyond the VaR Limit 305
Unspeakable Truth Number Three: Risk Managers Create Risk 309
Chapter 17 The Story of Risk 313
Chapter 18 Frequency versus Degree of Belief 323
Statistical Games 324
Thorp, Black, Scholes, and Merton 329
Change of Numeraire 333
Polling 336
The Quant Revolution 341
Chapter 19 The Secret History of Wall Street: 1993– 2007 345
Where Did the Money Come From? 348
Where Did They Put the Money? 359
Where Did the Money Go? 364
Chapter 20 The Secret History of Wall Street: The 2007 Crisis and Beyond 369
Postmortem 379
A Risk Management Curriculum 387
One Hundred Useful Books 393
About the Author 401
About the Illustrator 403
Index 405
Aaron Brown is risk manager at AQR Capital Management and the author of The Poker Face of Wall Street (Wiley), selected one of the ten best books of 2006 by BusinessWeek, and A World of Chance with Reuven and Gabrielle Brenner. In his thirty-year Wall Street career, he has been a trader, portfolio manager, head of mortgage securities, and risk manager for institutions including Citigroup and Morgan Stanley. He also served a stint as a finance professor and was among the top poker players in the world during the 1970s and 1980s. He holds degrees in applied mathematics from Harvard and in finance and statistics from the University of Chicago.
"Wickedly original, one of the most fascinating accounts I have ever seen. A rollicking and highly opinionated read." ( Risk Professional , October 2011) "No one who reads Red-Blooded Risk: The Secret History of Wall Street will ever again regard risk management as a necessary but unproductive appendage of the financial industry. Other authors have chronicled how quantitative finance influenced investment management, but Aaron Brown has made a compelling case for a far more profound economic impact... If Red-Blooded Risk: The Secret History of Wall Street dealt with nothing more than the inadequacy of models used in highly important activities, it would represent a valuable contribution to financial economics. Brown's book, however, covers a great deal more than econometric malpractice. Probably no other book offers as much insight into the process with so little resort to mathematical notation. Especially valuable are Brown's discussions of middle-office risk management and value at risk, comparatively recent innovations that are essential to understanding modern financial institutions. Readers of Red-Blooded Risk should be prepared to have many of their assumptions challenged . Red-Blooded Risk is one of the most original and thought-provoking books reviewed in these pages in the past 20 years. No one who reads it will ever again regard risk management as a necessary but unproductive appendage of the financial industry. Other authors have chronicled how quantitative finance influenced investment management, but Aaron Brown has made a compelling case for a far more profound economic impact." -- Martin S. Fridson , CFA Institute Publications Book Reviews "Red-Blooded Risk mixes risk history and philosophy nimbly and provides a perspective that can be both refreshing and challenging (often on the same page). While the book is not without weaknesses, it is also brimming with original perspectives and controversial opinions. Those who work in risk management or quantitative finance will enjoy Brown's story-telling and expert perspectives, even if they do not share his views, while non-quants will find his insights and confessions to be a useful glimpse into the psyche and ethos of an influential group of early quantitative risk takers. -- Roger M. Stein , Research and Academic Relations, Moody's Corporation, as reviewed in Quantitative Finance (August 6, 2012)
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