Red-Blooded Risk

Red-Blooded Risk : The Secret History of Wall Street

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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.

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Product details

  • Hardback | 432 pages
  • 154.94 x 231.14 x 30.48mm | 1,383.45g
  • John Wiley & Sons Inc
  • New York, United States
  • English
  • 1118043863
  • 9781118043868
  • 307,468

About Aaron Brown

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.

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Review quote

"Wickedly original, one of the most fascinating accounts I have ever seen. A rollicking and highly opinionated read." (Risk Professional, October 2011) No one who reads Red-Blooded Risk: The Secret History of Wall Street will ever again regard risk management as a necessary but unproductive appendage of the financial industry. Other authors have chronicled how quantitative finance influenced investment management, but Aaron Brown has made a compelling case for a far more profound economic impact... If Red-Blooded Risk: The Secret History of Wall Street dealt with nothing more than the inadequacy of models used in highly important activities, it would represent a valuable contribution to financial economics. Brown s book, however, covers a great deal more than econometric malpractice. Probably no other book offers as much insight into the process with so little resort to mathematical notation. Especially valuable are Brown s discussions of middle-office risk management and value at risk, comparatively recent innovations that are essential to understanding modern financial institutions. Readers of Red-Blooded Risk should be prepared to have many of their assumptions challenged. Red-Blooded Risk is one of the most original and thought-provoking books reviewed in these pages in the past 20 years. No one who reads it will ever again regard risk management as a necessary but unproductive appendage of the financial industry. Other authors have chronicled how quantitative finance influenced investment management, but Aaron Brown has made a compelling case for a far more profound economic impact. Martin S. Fridson, CFA Institute Publications Book Reviews Red-Blooded Risk mixes risk history and philosophy nimbly and provides a perspective that can be both refreshing and challenging (often on the same page). While the book is not without weaknesses, it is also brimming with original perspectives and controversial opinions. Those who work in risk management or quantitative finance will enjoy Brown s story-telling and expert perspectives, even if they do not share his views, while non-quants will find his insights and confessions to be a useful glimpse into the psyche and ethos of an influential group of early quantitative risk takers. Roger M. Stein, Research and Academic Relations, Moody s Corporation, as reviewed in Quantitative Finance (August 6, 2012)

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Flap copy

Everyone talks about risk, but few people give serious thought to what risk is. It's hard to describe it without expressing an opinion--we like things that are innovative, daring, creative, and bold; but those are exactly the same things that are reckless, speculative, risky, and irresponsible. This book is the story of a group of young math whizzes who unleashed a revolution--one that reshaped our financial system and continues to echo through the halls of government, universities, and corporations today. In the 1970s, disillusioned with the sorry state of quantitative analysis, these young mathematicians (soon to be known as "quants") invented a new way of looking at probability and set out to prove it in the ultimate testing ground of odds-making: Las Vegas. Once there, the quants turned conventional wisdom about gambling on its head. People said you can't beat the house, yet the quants managed to beat blackjack and other casino games. People said you needed a lifetime to learn poker, yet the quants' aggressive mathematical tactics swept the table against the best players in the world. Then the quants turned to sports betting, overturning the business model and squeezing out local bookies with a global organization that matched bets without taking risk. Armed with their theories and experience, the quants raised their sights and headed to Wall Street, determined to replicate their success. Finance was a tougher challenge than gambling, but by the mid-1990s, the quants had remade Wall Street as thoroughly as they had remade Las Vegas. That transformation went unnoticed by the bond salesmen and investment bankers who ran Wall Street, as well as by academics, regulators, journalists, and investors; yet these changes caused both the greatest wealth creation event in the history of the world, and also to the financial disasters we have witnessed in its wake. There's more here than just a lesson in recent financial history, however. Brown's story goes beyond the headlines to explore basic questions of economics, like the meaning of property and the nature of exchange. Along the way, it reveals secrets about the building of the pyramids, the glory of ancient Athens, the forcethat built the Roman Empire, a world-changing invention from medieval Italy, a secret in a mysterious letter written in 1654 and not decoded until the 1990s, and an essential aspect of the American Revolution left out of history books. This book will change the way you think about everything from history, risk, and money to vampires, zombies, and tulips. It offers a fascinating and thrilling account of great events that have never before been described in an easily accessible form. There are bold ideas, colorful characters, and, most important, the keys to understanding the modern financial world and how its inner workings affect our daily lives.

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Back cover copy

"Aaron Brown combines his characteristic no-nonsense approach to risk management with the latest, cutting-edge research in behavioral finance. The result makes other books on risk look pale and anemic by comparison." --Dylan Evans, author of Risk Intelligence "I highly recommend these ruminations on the history, philosophy, and practice of risk management; on risk, money, and the social value of derivatives markets; and much else written by a prominent risk management practitioner. This unconventional book is not only a good read but is also a treasure trove of valuable insights into trading and markets." --Jim Gatheral, professor at Baruch College and author of The Volatility Surface "Aaron Brown is the dean of Wall Street risk managers, and the one I respect the most. He describes risk clearly and presents techniques for managing it. My disagreement is with the applicability of those techniques to extreme tail events. Aside from that he has been my principal recourse in the field owing to his acuity, depth, and clarity of exposition." --Nassim Nicholas Taleb, professor at the Polytechnic Institute of New York University and author of The Black Swan "Aaron Brown eloquently explains the history of money and risk, and predicts a future with an increasing role for financial derivatives. After decades of serious poker playing and front-line risk management, he has a unique perspective. His blood is considerably redder than mine, which is looking rather pink after reading this book. I'm not sure I've got the nerve to follow all of his advice, but then again I like quiche." --Paul Wilmott, mathematician and winner of thePeel sandcastle-building competition, August 2001 "Aaron is a modern-day alchemist, able to transform complex and somewhat esoteric mathematical concepts into something easily understandable through the use of everydayexamples. He's a master of one of the most important skills required of any risk manager: the ability to communicate effectively. Red-Blooded Risk is uniquely written to appeal to both the novice and the professional." --Richard Apostolik, President and CEO, Global Association of Risk Professionals "An original and provocative introduction to risk by an experienced Wall Street manager. Entertaining and informative for beginners and professionals alike." --Edward O. Thorp, author of Beat the Dealer and Beat the Market

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Table of contents

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 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

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