This highly praised introductory treatment describes the parallels
between statistical physics and finance - both those established in
the 100-year long interaction between these disciplines, as well as
new research results on financial markets.
The random-walk technique, well known in physics, is also the
basic model in finance, upon which are built, for example, the
Black-Scholes theory of option pricing and hedging, plus methods of
portfolio optimization. Here the underlying assumptions are
assessed critically. Using empirical financial data and analogies
to physical models such as fluid flows, turbulence, or
superdiffusion, the book develops a more accurate description of
financial markets based on random walks. With this approach, novel
methods for derivative pricing and risk management can be
formulated. Computer simulations of interacting-agent models
provide insight into the mechanisms underlying unconventional price
dynamics. It is shown that stock exchange crashes can be modelled
in ways analogous to phase transitions and earthquakes, and
sometimes have even been predicted successfully.
This third edition of "The Statistical Mechanics of Financial
Markets" especially stands apart from other treatments because it
offers new chapters containing a practitioner's treatment of two
important current topics in banking: the basic notions and tools of
risk management and capital requirements for financial
institutions, including an overview of the new Basel II capital
framework which may well set the risk management standards in
scores of countries for years to come.
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