Volatility and Correlation: The Perfect Hedger and the Fox, 2nd Edition

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The new edition of \"Volatility and Correlation\" has been thoroughly updated and expanded with over 80ew or reworked material, reflecting the changes and developments that have taken place in the field. The new and updated material includes: empirical and theoretical analysis of the smile dynamics; examination of the perfect-replication model in relation to exotic options; treatment of additional important models, namely, Variance Gamma, displaced diffusion, CEV, stochastic volatility for interest-rate smiles and equity/FX options; questioning of the informational efficiency of markets in commonly-used calibration and hedging practices. The book is split into four sections. Part I deals with a deterministic-volatility Black world (no smiles), and sets out the author\'s \'philosophical\' approach to option pricing. Part II deals with smiles in the equity and FX worlds. Beginning with a review of relevant empirical information about smiles, this part provides coverage of local-stochastic-volatility, general-stochastic-volatility, jump-diffusion and Variance-Gamma processes. Part II concludes with an important chapter that discusses if and to what extent one can dispense with an explicit specification of a process-based model, and can directly prescribe the dynamics of the smile surface. Part III focuses on interest rates, and part IV extends the setting used for the deterministic-volatility LIBOR market model in order to account for interest-rate smiles in a financially-motivated and computationally-tractable manner. In this final part the author deals, in increasing levels of complexity, with CEV processes, with diffusive stochastic volatility and with Markov-chain processes. Covering FX, equity and interest-rate products, \"Volatility and Correlation\" is a blend of theoretical and practical material and is designed for traders, risk managers, financial professionals and students. \'The second edition is even more comprehensive than the first, and ideally suited to quantitatively oriented traders and risk managers. Rebonato has a knack for distilling the essence from a wide range of complex option pricing models.\' Darrell Duffie, Stanford University, USA \'The author has greatly extended the first edition of this book, whose main merit remains its courage to deal with relevant issues for practitioners. Rather than concentrating on fictional problems stemming from the need to give financial ground to one\'s favourite theories, the author moves from problems posed by the market. At times a colloquial stance is privileged over mathematical rigor and formalism, allowing a larger public to benefit from this book.\' Damiano Brigo, Head of Credit Models, Banca IMI, author of \"Interest Rate Models: Theory and Practice.\" \'This book is about equity, FX and interest-rate option pricing at its best. It combines rigorous theory with practical knowledge of markets and models. Riccardo Rebonato uses his technical mastery to make the theory clear, and his wealth of experience to give insights into applications. Whatever your level of knowledge of these markets, you will learn from him.\' Ian Cooper, Professor of Finance, London Business School \'In this book, Riccardo Rebonato discloses his invaluable expertise, shedding light over the gloomy path of modern model selection for pricing and hedging derivatives. Both practitioners and academics will benefit from histeachings and advice.\' Fabio Mercurio, Head of Financial Models, Banca IMI, Milan, ItalyIn \"Volatility and Correlation 2nd edition: The Perfect Hedger and the Fox,\" Rebonato looks at derivatives pricing from the angle of volatility and correlation. With both practical and theoretical applications, this is a thorough update of the highly successful \"Volatility & Correlation\" - with over 80% new or fully reworked material and is a must have both for practitioners and for students. The new and updated material includes a critical examination of the \'perfect-replication\' approach to derivatives pricing, with special attention given to exotic options; a thorough analysis of the role of quadratic variation in derivatives pricing and hedging; a discussion of the informational efficiency of markets in commonly-used calibration and hedging practices. Treatment of new models including Variance Gamma, displaced diffusion, stochastic volatility for interest-rate smiles and equity/FX options. The book is split into four parts. Part I deals with a Black world without smiles, sets out the author\'s \'philosophical\' approach and covers deterministic volatility. Part II looks at smiles in equity and FX worlds. It begins with a review of relevant empirical information about smiles, and provides coverage of local-stochastic-volatility, general-stochastic-volatility, jump-diffusion and Variance-Gamma processes. Part II concludes with an important chapter that discusses if and to what extent one can dispense with an explicit specification of a model, and can directly prescribe the dynamics of the smile surface. Part III focusses on interest rates when the volatility is deterministic. Part IV extends this setting in order to account for smiles in a financially motivated and computationally tractable manner. In this final part the author deals with CEV processes, with diffusive stochastic volatility and with Markov-chain processes. Praise for the First Edition: \"In this book, Dr Rebonato brings his penetrating eye to bear on option pricing and hedging.... The book is a must-read for those who already know the basics of options and are looking for an edge in applying the more sophisticated approaches that have recently been developed.\" --Professor Ian Cooper, London Business School \"Volatility and correlation are at the very core of all option pricing and hedging. In this book, Riccardo Rebonato presents the subject in his characteristically elegant and simple fashion...A rare combination of intellectual insight and practical common sense.\" --Anthony Neuberger, London Business School