Note: This content is accessible to all versions of every browser. However, this browser does not seem to support current Web standards, preventing the display of our site's design details.


Risk Management with Behavioural Factors

In several countries a major factor contributing to the current economic crisis was massive borrowing to fund investment projects on the basis of, in retrospect, grossly optimistic valuations. We develop an approach to project valuation and risk management in which 'behavioural' factors can be explicitly included. An appropriate framework is risk-neutral valuation based on the use of the numeraire portfolio -- the 'benchmark' approach advocated by Platen and Heath (2006). We start by discussing the ingredients of the problem: 'animal spirits', financial instability, market-consistent valuation, the numeraire portfolio and structural models of credit risk. We then study a project finance problem in which a bank lends money to an entrepreneur, collateralized by the value of the latter's investment project. This contains all the components of our approach in a simple setting and illustrates what steps are required. In a final section, we outline the computational and econometric problems that arise in real applications. This is joint work with Sebastien Lleo and Grzegorz Andruszkiewicz []

Type of Seminar:
Optimization and Applications Seminar
Prof. Mark Davis
Department of Mathematics, Imperial College London, UK
Nov 19, 2012   16:30

HG G 19.1
Contact Person:

John Lygeros
File Download:

Request a copy of this publication.
Biographical Sketch:
Mark Davis is Distinguished Research Fellow in the Department of Mathematics at Imperial College London. He is also Quantitative Research Adviser to Hanover Square Capital (UK) Ltd, in connection with India-related investment funds. From 2000-2009 he was Professor and Head of the Mathematical Finance group at Imperial College. His research concentrates on stochastic analysis and financial mathematics, in particular credit risk models, pricing in incomplete markets and stochastic volatility. From 1995-1999 he was Head of Research and Product Development at the investment bank Tokyo-Mitsubishi International (now Mitsubishi UFJ Securitites International plc), leading a front-office group providing pricing models and risk analysis for fixed-income, equity and credit-related products. Dr Davis holds a PhD from the University of California Berkeley and is the author of five books on stochastic analysis, optimisation and finance, most recently "Louis Bachelier's Theory of Speculation" (Princeton University Press 2006) written with Alison Etheridge. He was a founding co-editor of the journal Mathematical Finance (1990-93) and is currently an associate editor of Quantitative Finance and the SIAM Journal of Financial Mathematics. He was awarded the Naylor Prize in Applied Mathematics by the London Mathematical Society in 2002.