Modeling Risk

Description

Contents......Page 19 Preface......Page 27 What’s New in the Second Edition......Page 29 Acknowledgments......Page 31 About the Author......Page 33 Introduction......Page 39 Part One. Risk Identification......Page 47 A Brief History of Risk: What Exactly is Risk?......Page 49 Uncertainty versus Risk......Page 50 Why is Risk Important in Making Decisions?......Page 52 Dealing with Risk the Old-Fashioned Way......Page 56 The Look and Feel of Risk and Uncertainty......Page 59 Integrated Risk Management Framework......Page 61 Questions......Page 67 Part Two. Risk Evaluation......Page 69 Taming the Beast......Page 71 The Basics of Risk......Page 73 The Statistics of Risk......Page 74 The Measurements of Risk......Page 80 Appendix—Computing Risk......Page 82 Questions......Page 92 Document the Model......Page 94 Separate Inputs, Calculations, and Results......Page 97 Protect the Models......Page 99 Make the Model User-Friendly: Data Validation and Alerts......Page 100 Track the Model......Page 102 Automate the Model with VBA......Page 103 Model Aesthetics and Conditional Formatting......Page 104 Appendix—A Primer on VBA Modeling and Writing Macros......Page 105 Exercises......Page 114 Part Three. Risk Quantification......Page 117 Chapter 4. On the Shores of Monaco......Page 119 Why Are Simulations Important?......Page 120 Comparing Simulation with Traditional Analyses......Page 123 Using Risk Simulator and Excel to Perform Simulations......Page 126 Questions......Page 132 Getting Started with Risk Simulator......Page 133 Running a Monte Carlo Simulation......Page 135 Using Forecast Charts and Confidence Intervals......Page 146 Correlations and Precision Control......Page 150 Appendix—Understanding Probability Distributions......Page 156 Appendix—ROV Compiler: Protects and Converts Excel Files into Executable EXE......Page 180 Appendix—ROV Extractor and Evaluator: Runs Extreme Super Speed Simulations and Converts Excel Models into a Calculator Environment......Page 184 Exercises......Page 187 Tornado and Sensitivity Tools in Simulation......Page 216 Sensitivity Analysis......Page 225 Distributional Fitting: Single Variable and Multiple Variables......Page 230 Bootstrap Simulation......Page 234 Hypothesis Testing......Page 237 Data Extraction, Saving Simulation Results, and Generating Reports......Page 241 Distributional Analysis Tool......Page 242 Segmentation Clustering Tool......Page 247 Structural Break Analysis......Page 248 Principal Component Analysis......Page 250 Appendix—Goodness-of-Fit Tests......Page 251 Questions......Page 253 Exercises......Page 254 Part Four. Industry Applications......Page 321 Chapter 7. Extended Business Cases I: Pharmaceutical and Biotech Negotiations, Oil and Gas Exploration, Financial Planning with Simulation, Hospital Risk Management, Risk-Based Executive Compensation Valuation, and Risk-Based Schedule Planning......Page 323 Case Study: Pharmaceutical and Biotech Deal Structuring......Page 324 Case Study: Oil and Gas Exploration and Production......Page 344 Case Study: Financial Planning with Simulation......Page 356 Case Study: Hospital Risk Management......Page 366 Case Study: Risk-Based Executive Compensation Valuation......Page 386 Case Study: Risk-Based Schedule Planning with Simulation......Page 395 Part Five. Risk Prediction......Page 407 Different Types of Forecasting Techniques......Page 409 Running the Forecasting Tool in Risk Simulator......Page 413 Time-Series Analysis......Page 414 Multivariate Regression......Page 418 Stepwise Regression......Page 421 Stochastic Forecasting......Page 424 Nonlinear Extrapolation......Page 428 Box–Jenkins ARIMA Advanced Time-Series......Page 430 Auto ARIMA (Box–Jenkins ARIMA Advanced Time-Series)......Page 435 Basic Econometrics......Page 437 J-Curve and S-Curve Forecasts......Page 439 GARCH Volatility Forecasts......Page 441 Markov Chains......Page 444 Maximum Likelihood Models on Logit, Probit, and Tobit......Page 446 Questions......Page 449 Exercise: Forecasting......Page 451 Time-Series Forecasting Methodology......Page 464 No Trend and No Seasonality......Page 465 With Trend but No Seasonality......Page 471 No Trend but with Seasonality......Page 473 With Seasonality and with Trend......Page 477 Regression Analysis......Page 479 The Pitfalls of Forecasting: Outliers, Nonlinearity, Multicollinearity, Heteroskedasticity, Autocorrelation, and Structural Breaks......Page 495 Other Technical Issues in Regression Analysis......Page 509 Regression and Forecasting Diagnostic Tool......Page 511 Statistical Analysis Tool......Page 521 Appendix—Forecast Intervals......Page 527 Appendix—Ordinary Least Squares......Page 528 Appendix—Detecting and Fixing Heteroskedasticity......Page 531 Appendix—Detecting and Fixing Multicollinearity......Page 532 Appendix—Detecting and Fixing Autocorrelation......Page 534 Exercise......Page 535 Part Six. Risk Diversification......Page 537 What Is an Optimization Model?......Page 539 The Traveling Financial Planner......Page 540 The Lingo of Optimization......Page 542 Solving Optimization Graphically and Using Excel’s Solver......Page 545 Questions......Page 551 Optimization Procedures......Page 552 Continuous Optimization......Page 555 Discrete Integer Optimization......Page 561 Efficient Frontier and Advanced Optimization Settings......Page 564 Stochastic Optimization......Page 568 Optimization Application Example: Military Portfolio and Efficient Frontier......Page 573 Optimization Application Example: Optimal Pricing with Elasticity......Page 577 Appendix—ROV Modeler Suite: Server-Based Applications for Running Data-Intensive Models at Extremely High Speeds......Page 582 Appendix—Computing Annualized Returns and Risk for Portfolio Optimization......Page 600 Exercise: Optimization......Page 604 Questions......Page 617 Part Seven. Risk Mitigation......Page 619 What Are Real Options?......Page 621 The Real Options Solution in a Nutshell......Page 623 Issues to Consider......Page 624 Implementing Real Options Analysis......Page 625 Types of Real Options Strategies......Page 626 Industry Leaders Embracing Real Options......Page 628 More Sample Applications and Short Cases......Page 631 What the Experts Are Saying......Page 644 Criticisms, Caveats, and Misunderstandings in Real Options......Page 647 Questions......Page 650 Chapter 13. The Black Box Made Transparent: Real Options Super Lattice Solver Software......Page 651 Single Asset Super Lattice Solver......Page 653 Multiple Asset Super Lattice Solver......Page 662 Multinomial Super Lattice Solver......Page 664 SLS Excel Solution (SLS, MSLS, and Changing Volatility Models in Excel)......Page 666 SLS Functions......Page 669 Payoff Charts, Tornado Sensitivity, Scenario, and Convergence Analysis......Page 673 Key SLS Notes and Tips......Page 679 Exercises......Page 682 Part Eight. More Industry Applications......Page 711 Chapter 14. Extended Business Cases II: Real Estate, Banking, Military Strategy, Automotive Aftermarkets, Global Earth Observation Systems, Employee Stock Options, Oil and Gas Royalty Lease Negotiations, Real Options and IT Enterprise Risk Security, Basel II Credit and Market Risk Analysis, and IT Information Security Intrusion Risk Management......Page 713 Case Study: Understanding Risk and Optimal Timing in a Real Estate Development Using Real Options Analysis......Page 714 Case Study: Using Stochastic Optimization and Valuation Models to Evaluate the Credit Risk of Corporate Restructuring......Page 730 Case Study: Real Options and KVA in Military Strategy at the United States Navy......Page 736 Case Study: Manufacturing and Sales in the Automotive Aftermarket......Page 747 Case Study: The Boeing Company’s Strategic Analysis of the Global Earth Observation System of Systems......Page 757 Case Study: Valuing Employee Stock Options Under the 2004 FAS 123R......Page 767 Case Study: Oil and Gas Royalty Lease Negotiation......Page 798 Case Study: How Real Options Mitigates IT Enterprise Security Risks......Page 818 Case Study: Basel II Credit Risk and Market Risk......Page 833 Case Study: IT Information Security Intrusion Risk Management......Page 879 Part Nine. Risk Management......Page 901 The Problem of Negligent Entrustment......Page 903 Sins of an Analyst......Page 904 Reading the Warning Signs in Monte Carlo Simulation......Page 906 Reading the Warning Signs in Time-Series Forecasting and Regression......Page 917 Reading the Warning Signs in Real Options Analysis......Page 922 Reading the Warning Signs in Optimization under Uncertainty......Page 925 Questions......Page 926 Change-Management Issues and Paradigm Shifts......Page 927 Making Tomorrow’s Forecast Today......Page 931 Parting Shots and a Word of Caution from the Author......Page 932 Notes......Page 943 Tables You Really Need......Page 953 Standard Normal Distribution (partial area)......Page 954 Standard Normal Distribution (full area)......Page 955 Student’s t-Distribution (one and two tails)......Page 956 Durbin–Watson Critical Values (alpha 0.05)......Page 957 Normal Random Numbers (standard normal distribution’s random number generated ∼ (N(0, 1))......Page 958 Random Numbers (multiple digits)......Page 960 Uniform Random Numbers (uniform distribution’s random number generated between 0.0000 and 1.0000)......Page 962 Chi-Square Critical Values......Page 964 F-Distribution Critical Statistics (alpha one tail 0.10)......Page 966 F-Distribution Critical Statistics (alpha one tail 0.05)......Page 968 F-Distribution Critical Statistics (alpha one tail 0.025)......Page 970 F-Distribution Critical Statistics (alpha one tail 0.01)......Page 972 Real Options Analysis Values (1-year maturity at 5% risk-free rate)......Page 974 Real Options Analysis Values (3-year maturity at 5% risk-free rate)......Page 976 Real Options Analysis Values (5-year maturity at 5% risk-free rate)......Page 978 Real Options Analysis Values (7-year maturity at 5% risk-free rate)......Page 980 Real Options Analysis Values (10-year maturity at 5% risk-free rate)......Page 982 Real Options Analysis Values (15-year maturity at 5% risk-free rate)......Page 984 Real Options Analysis Values (30-year maturity at 5% risk-free rate)......Page 986 Answers to End of Chapter Questions......Page 989 What’s on the DVD......Page 997 Customer Care......Page 998 Index......Page 1001