This book establishes a strong foundation in risk management. It leans substantially on decision theory and behavioral economics. Its main concept is "regret." Regret is downside risk. We can insure against that downside risk by buying a Put option. Even if we deal in illiquid markets where such options are not available, it is still key to calculate the economic value of regret or of that Put option (if it were to exist). Similarly, the upside of a transaction is equivalent to buying a Call option. Mr. Dembo comes up with this equation: Upside - Lambda(Regret). Lambda captures your risk tolerance. If your risk tolerance is high, Lambda will be small. The inverse is true too.
With this straightforward model, the authors can explain a whole lot of economic incentives with a behavioral component. For instance, you can easily explain why most people would not mind playing roulette with just a dollar bill. But, the same people would not play with $100 dollar bills. In effect, most people would rather take on a bad risk (with poor odds) on a small scale, than take on a better risk (better odds) on a larger scale.
- Hardcover: 272 pages
- Publisher: John Wiley & Sons; 1st edition (20 May 1998)
- Language: English
- ISBN-10: 0471247367
- ISBN-13: 978-0471247364
- Product Dimensions: 15.9 x 2.5 x 23.5 cm
- Boxed-product Weight: 544 g
- Average Customer Review: Be the first to review this item
- Amazon Bestsellers Rank: 220,874 in Books (See Top 100 in Books)