Derivatives and internal models

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Now in its fifth edition, this comprehensive guide offers an in-depth introduction to derivative pricing, risk management, and portfolio optimization. It covers essential topics with sufficient detail to enable readers to create their own pricing and risk tools. The book explores modern market risk quantification methods, including variance-covariance, historical simulation, and Monte Carlo techniques, alongside statistical concepts like GARCH Models and Chi-Square distributions. It illustrates how to deduce optimal trading decisions through risk-adjusted performance measures and presents a thorough overview of contemporary quantitative portfolio optimization. Key modern derivatives and their pricing methods are discussed, ranging from basic discounted cash flow techniques to advanced models like Black-Scholes, binomial trees, differential equations, finite difference schemes, and Martingales. The fifth edition has been extensively reviewed, incorporating new chapters on multicurve bootstrapping and the valuation and hedging of credit default risk—topics that have gained significance due to recent financial crises. Additionally, the book includes downloadable Excel spreadsheets, demonstrating how theoretical concepts can be transformed into practical algorithms and applications, serving as a valuable resource for readers developing their own valuation and risk management systems.