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Financial Market Complexity$
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Neil F. Johnson, Paul Jefferies, and Pak Ming Hui

Print publication date: 2003

Print ISBN-13: 9780198526650

Published to Oxford Scholarship Online: January 2010

DOI: 10.1093/acprof:oso/9780198526650.001.0001

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Non-zero risk in the real world

Non-zero risk in the real world

Chapter:
(p.161) 6 Non-zero risk in the real world
Source:
Financial Market Complexity
Author(s):

NEIL F. JOHNSON

PAUL JEFFERIES

PAK MING HUI

Publisher:
Oxford University Press
DOI:10.1093/acprof:oso/9780198526650.003.0006

Chapter 2 looked at how an investor might use derivatives to manage risk. In order for the Black–Scholes pricing theory to work, several major assumptions were made about how financial markets behave. This chapter re-visits the whole question of risk and derivatives for real-world markets, without automatically making these assumptions. Consequently, the formalism in this chapter is more complicated than that in Chapter 2: therefore it is presented in a pedagogical manner while emphasizing the practical steps that one needs to take to implement it. The formalism is built upon the landmark work of Bouchaud and Sornette. In addition to discussing the practical implementation of their inherently non-Black–Scholes scheme, the chapter also addresses the crucial issue of managing portfolios in the presence of non-zero transaction costs.

Keywords:   financial markets, derivatives, risk management, risk reduction, formalism, Black–Scholes theory

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