An innovative guide that identifies what distinguishes the best financial risk takers from the rest
From 1987 to 1992, a small group of Wall Street quants invented an entirely new way of managing risk to maximize success: risk management for risk-takers. This is the secret that lets tiny quantitative edges create hedge fund billionaires, and defines the powerful modern global derivatives economy. The same practical techniques are still used today by risk-takers in finance as well as many other fields. Red-Blooded Risk examines this approach and offers valuable advice for the calculated risk-takers who need precise quantitative guidance that will help separate them from the rest of the pack.
While most commentators say that the last financial crisis proved it's time to follow risk-minimizing techniques, they're wrong. The only way to succeed at anything is to manage true risk, which includes the chance of loss. Red-Blooded Risk presents specific, actionable strategies that will allow you to be a practical risk-taker in even the most dynamic markets.
Contains a secret history of Wall Street, the parts all the other books leave out
Includes an intellectually rigorous narrative addressing what it takes to really make it in any risky activity, on or off Wall Street
Addresses essential issues ranging from the way you think about chance to economics, politics, finance, and life
Written by Aaron Brown, one of the most calculated and successful risk takers in the world of finance, who was an active participant in the creation of modern risk management and had a front-row seat to the last meltdown
Written in an engaging but rigorous style, with no equations
Contains illustrations and graphic narrative by renowned manga artist Eric Kim
There are people who disapprove of every risk before the fact, but never stop anyone from doing anything dangerous because they want to take credit for any success. The recent financial crisis has swelled their ranks, but in learning how to break free of these people, you'll discover how taking on the right risk can open the door to the most profitable opportunities.
AARON BROWN is risk manager at AQR Capital Management and the author of The Poker Face of Wall Street (Wiley), selected one of the ten best books of 2006 by BusinessWeek, and A World of Chance with Reuven and Gabrielle Brenner. In his thirty-year Wall Street career, he has been a trader, portfolio manager, head of mortgage securities, and risk manager for institutions including Citigroup and Morgan Stanley. He also served a stint as a finance professor and was among the top poker players in the world during the 1970s and 1980s. He holds degrees in applied mathematics from Harvard and in finance and statistics from the University of Chicago.
Acknowledgments xi Chapter 1 What This Book Is and Why You Should Read It 1 Risk, Danger, and Opportunity 2 Red- Blooded Risk Management 4 Risk and Life 7 Play and Money 9 Frequentism 11 Rationality 13 Bets 15 Exponentials and Culture 18 Payoff 20 Chapter 2 Red Blood and Blue Blood 23 Chapter 3 Pascal's Wager and the Seven Principles of Risk Management 29 Principle I: Risk Duality 32 Principle II: Valuable Boundary 33 Principle III: Risk Ignition 35 Principle IV: Money 38 Outside the VaR Boundary 40 Principle V: Evolution 45 Principle VI: Superposition 48 Principle VII: Game Theory 49 Chapter 4 The Secret History of Wall Street: 1654 1982 57 Pascal and Fermat 58 Poker 61 Advantage Gamblers 62 Sports Betting 63 Quants to Wall Street 66 Finance People 68 Real Finance 69 Chapter 5 When Harry Met Kelly 73 Kelly 74 Harry 76 Commodity Futures 79 If Harry Knew Kelly 84 Investment Growth Theory 88 eRaider.com 92 MPT Out in the World 96 Chapter 6 Exponentials, Vampires, Zombies, and Tulips 101 Types of Growth 102 The Negative Side 105 Tulips 106 Tulip Propaganda 108 Quantitative Tulip Modeling 111 Money 112 Chapter 7 Money 117 Chapter 8 The Story of Money: The Past 125 Property, Exchange, and Money 126 Paleonomics 128 Transition 131 What Money Does 134 Risk 135 Government and Paper 138 Paper versus Metal 142 1776 and All That 145 Andrew Dexter 147 A Short Digression into Politics and Religion 150 Chapter 9 The Secret History of Wall Street: 1983 1987 155 Effi cient Markets 157 Anomalies 159 The Price Is Right . . . Not! 161 Effi ciency versus Equilibrium 162 Beating the Market 165 Paths 170 Sharpe Ratios and Wealth 174 1987 177 Chapter 10 The Story of Money: The Future 179 Farmers and Millers 180 Money, New and Improved 183 A General Theory of Money 185 Value and Money 189 Numeraire 191 Clearinghouses 196 Cash 197 Derivative Money 200 The End of Paper 203 Chapter 11 Cold Blood 207 Chapter 12 What Does a Risk Manager Do? Inside VaR 213 Professional Standards 213 Front Offi ce 215 Trading Risk 217 Quants on the Job 218 Middle Office 222 Back Office 225 Middle Office Again 227 Looking Backward 228 Risk Control 230 Beyond Profi t and Loss 232 Numbers 234 The Banks of the Charles 236 Waste 238 The Banks of the Potomac 241 The Summer of My Discontent 245 Validation 247 Chapter 13 VaR of the Jungle 251 Chapter 14 The Secret History of Wall Street: 1988 1992 255 Smile 256 Back to the Dissertation 258 Three Paths 262 An Unexpected Twist 265 Surprise! 267 Computing VaR 271 Chapter 15 Hot Blood and Thin Blood 277 Chapter 16 What Does a Risk Manager Do? Outside VaR 283 Stress Tests 283 Trans- VaR Scenarios 287 Black Holes 289 Why Risk Managers Failed to Prevent the Financial Crisis 290 Managing Risk 296 Unspeakable Truth Number One: Risk Managers Should Make Sure Firms Fail 299 Unspeakable Truth Number Two: There s Good Stuff beyond the VaR Limit 305 Unspeakable Truth Number Three: Risk Managers Create Risk 309 Chapter 17 The Story of Risk 313 Chapter 18 Frequency versus Degree of Belief 323 Statistical Games 324 Thorp, Black, Scholes, and Merton 329 Change of Numeraire 333 Polling 336 The Quant Revolution 341 Chapter 19 The Secret History of Wall Street: 1993 2007 345 Where Did the Money Come From? 348 Where Did They Put the Money? 359 Where Did the Money Go? 364 Chapter 20 The Secret History of Wall Street: The 2007 Crisis and Beyond 369 Postmortem 379 A Risk Management Curriculum 387 One Hundred Useful Books 393 About the Author 401 About the Illustrator 403 Index 405