Applied Risk Management:
Valuation of Derivatives under AI and Data Science Technologies

Gordon H Dash and Nina Kajiji

Table of Contents




Chapter 1

Introduction to Risk Management and Derivatives
In addition to providing a framework by which to classify the concept of risk, the purpose of this chapter is to introduce the study of risk management for individual securities and portfolios using derivative instruments, neuroeconomic models and automated trading.


Part I:  Options Markets and Valuation Analytics

Chapter 2

Option Contract Basics
This chapter develops a uniform approach for measuring the statistical characteristics of traded instruments. The discussion begins with the development of simple averages and concludes with the development of volatility. Both historical and implied volatility are covered in detail; a presentation that includes a development of the volatility “smile” and “event surface.”

Chapter 3

Market Characteristics of Traded Instruments
This chapter provides a structured overview of global derivatives markets.  The chapter presents the terminology of traded options including coverage of the put-call-parity theorem.

Chapter 4

The Binomial Option Pricing Model
This chapter presents the single- and multi-period Binomial Option Pricing Model.  Detailed examples with calculator solutions are provided.

Chapter 5

The Black and Scholes Option Pricing Model
This chapter presents Black and Scholes Option Pricing Model. Computational differences between the Binomial approach and the Black-and-Scholes pricing model are provided. Development of option Greeks and a detailed calculation-based approach to estimate implied volatility are presented. The discussion is enhanced to support preparation for all qualifying examinations: Actuarial Society examination, FRM and PRM.


Part II:  Option Instruments and Valuation Analytics

Chapter 6

Fundamental Option Strategies
A description and definition of the basic option strategies for both call and put contracts.  Includes coverage of covered calls and puts for portfolio insurance.  Focus is on both micro-hedges (individual securities) and macro hedges (portfolios using index-based contracts).

Chapter 7

Advanced Option Spread Strategies
This chapter describes and develops many of the well-known option spread strategies. Close linkage to real-time applications using WinORS.  Spreads include various versions of butterflies, guts, condors, straddles and more.  Applicable for both individual securities and portfolios.

Chapter 8

Real Options and Capital Investment Analysis
This chapter provides an advanced treatment of the capital investment (budgeting) decision in the selection of long-term assets. Discussion on how to approach large-scale and complex capital budgeting decisions using combinatorial optimization is featured. Real option approaches demonstrate how to deploy option pricing models to risk-mitigate complex capital budgeting problems.


Part III:  Futures Instruments and Swap Agreements

Chapter 9

The Foundation of Modern Futures Markets
The chapter presents and discusses the contemporary futures markets. References and comparisons are provided for both the global and domestic futures markets. The discussion continues with the development of futures pricing theories. 

Chapter 10

Fundamental Applications of Equity Futures Pricing
This is an applications-based chapter linked to simulation and back-testing algorithms within WinORS.  There is a strong focus on the calculation of real-time hedge ratios for equity portfolios.  State-of-the-art non-Gaussian risk-adjusted performance measures are introduced with calculation based examples.

Chapter 11

The Single Stock Futures Markets
The chapter focuses on the robust Single Stock Futures Exchange. Linkages to both single stock futures, exchange for physicals, and exchange traded futures for equity and fixed income instruments is provided.

Chapter 12

Fundamental Applications of Fixed Income Futures
The WinORS bond valuation system focus on the portfolio valuation of risk-mitigating trading bonds across a number of different markets.  Markets covered include Treasuries, munis, corporate and zero-coupon.  Full coverage across a wide-number of analytical measures with supporting graphical output. Fixed income hedge methods provide a robust approach to the theory and approach of risk mitigating fixed income portfolios

Chapter 13

Swaps, Interest Rate, and Credit Derivatives
The chapter presents a detailed discussion on the valuation and use of swap agreements. In addition to providing an overview of the swaps market, interest rate swaps and associated option derivatives, or swaptions, are exemplified by practical applications. The chapter closes with a look at credit default swap contracts.


Part IV:  Neuroeconomics and Applied Risk Management

Chapter 14

Machine Learning, AI, and Modern Investing Techniques
The application of artificial intelligence through dual neural networks to predict end-of-day and high-frequency stock prices for the purpose of optimizing trading profitability with minimization of wrong-direction trade errors. 

Chapter 15

Neuroeconomics and Applied Automated Trading
This chapter presents an introduction of how operational artificial intelligence in the form of artificial neural networks are used to predict near high-frequency and end-of-day stock prices for the purpose of optimizing risk-adjusted trading profitability. Special emphasis is place on how to minimize wrong directional trade rules. 

Chapter 16

Automated Trading: Policies and Performance
An examination of the external and internal policies that guide the operation of the fully accessible WINKS automated trading system.  The chapter includes a detailed examination of real-time and historical risk-adjusted performance for both individual securities and all managed portfolios.  ESG and sector  performance reports are also provided.

Chapter 17

Neuroeconomics and Big Data in the Capital Markets
This chapter addresses  the question: What is a Big Data CAPM? The chapter begins by differentiating among the terms data analytics, data visualization and predictive analytics.  The chapter includes a “Big Data” exploration and critical evaluation of the equilibrium based CAPM valuation model.


Part V:  Advances in Fund Construction and Optimization

Chapter 18

Global Portfolio Creation and Management
This chapter introduces basic equity portfolio building skills needed to use the proprietary WINKS portfolio management system.  The chapter covers how to set portfolio strategy and objectives; particularly for automated trading. How to generate a basic mean-variance efficient set for user entered portfolio is also demonstrated. The efficient use of global WINKS web server and integrated automated trading system is emphasized throughout.

Chapter 19

Mean-Variance Portfolio Diversification
This chapter introduces advanced concepts and tools for state-of-the-art efficient diversification.  Multiple types of mean-variance (MV) portfolio calculations are covered.  

Chapter 20

Diagonal Models for Portfolio Diversification
This chapter introduces additional portfolio models such as the Sharpe single index model. Other variants to the Sharpe model such as multi-index, lambda model, short-sales are also discussed.  Adding managerial and legal constraints to either diversification approach is presented and demonstrated.

Chapter 21

Behavioral Portfolio Optimization
This chapter discusses how one can implement hierarchical objectives for solving a multiple objective behavioral portfolio model

Chapter 22

The Foundation of the Hedge Fund Market
This introduces fundamental hedge fund styles and characteristics.  Experientially, the chapter uses the derivative valuation skills taught across preceding chapters to demonstrate how to convert an equity portfolio to a long-short hedge fund.  The topics demonstrate how to add advanced option spread strategies for individual equities into the portfolio. How to use and simulate index futures hedges against the equity portfolio is also discussed and demonstrated.

Chapter 23

Comparative Hedge Fund Performance
Are all hedge funds created equal? This chapter addresses the different risk adjusted return metrics that are required to correctly and adequately compare alternative styles of hedge funds.  Emphasis is given to the distribution of returns which, for most hedge funds, are non-Gaussian.


ISBN: 978-0-9908843-0-9, The NKD Group, Inc., 2010-2021, All Rights Reserved

Updated: 20-Apr-2020

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