Modeling Risk: Applying Monte Carlo Simulation, Real Options Analysis, Forecasting, and Optimization Techniques (Wiley Finance)

623 Pages·2006·31.57 MB·English

by  Johnathan Mun

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Modeling
Risk
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Modeling
Risk
Applying Monte Carlo Simulation,
Real Options Analysis, Forecasting,
and Optimization Techniques
JOHNATHAN MUN
John Wiley & Sons, Inc.
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Copyright © 2006 by Johnathan Mun. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data:
Mun, Johnathan.
Modeling risk : applying Monte Carlo simulation, real options analysis, forecasting, and
optimization techniques / Johnathan Mun
p. cm.—(Wiley finance series)
Includes index.
ISBN-13 978-0-471-78900-0 (cloth/cd-rom)
ISBN-10 0-471-78900-3 (cloth/cd-rom)
1. Risk assessment. 2. Risk assessment—Mathematical models. 3. Risk management.
4. Finance—Decision making. I. Title. II. Series.
HD61.M7942 2006
658.15—dc22 2005058120
Printed in the United States of America.
10 9 8 7 6 5 4 3 2 1
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To my wife Penny, the love of my life.
In a world where risk and uncertainty abound,
you are the only constant in my life.
Delight yourself in the Lord and
he will give you the desires of
your heart.
Psalms 37:4
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Preface
W
e live in an environment fraught with risk and operate our businesses in
a risky world, as higher rewards only come with risks. Ignoring the el-
ement of risk when corporate strategy is being framed and when tactical
projects are being implemented would be unimaginable. In addressing the
issue of risk, Modeling Risk provides a novel view of evaluating business de-
cisions, projects, and strategies by taking into consideration a unified strate-
gic portfolio analytical process. This book provides a qualitative and
quantitative description of risk, as well as introductions to the methods used
in identifying, quantifying, applying, predicting, valuing, hedging, diversify-
ing, and managing risk through rigorous examples of the methods’ applica-
bility in the decision-making process.
Pragmatic applications are emphasized in order to demystify the many
elements inherent in risk analysis. A black box will remain a black box if no
one can understand the concepts despite its power and applicability. It is
only when the black box becomes transparent so that analysts can under-
stand, apply, and convince others of its results, value-add, and applicability,
that the approach will receive widespread influence. The demystification of
risk analysis is achieved by presenting step-by-step applications and multiple
business cases, as well as discussing real-life applications.
This book is targeted at both the uninitiated professional and those well
versed in risk analysis—there is something for everyone. It is also appropri-
ate for use at the second-year M.B.A. level or as an introductory Ph.D. text-
book. A CD-ROM comes with the book, including a trial version of the Risk
Simulator and Real Options Super Lattice Solver software and associated
Excel models.
JOHNATHANMUN
San Francisco, California
[email protected]
May 2006
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Acknowledgments
T
he author is greatly indebted to Robert Fourt, Professor Morton Glantz,
Dr. Charles Hardy, Steve Hoye, Professor Bill Rodney, Larry Pixley, Dr.
Tom Housel, Lt. Commander Cesar Rios, Ken Cobleigh, Pat Haggerty, Larry
Blair, Andy Roff, and Tony Jurado for their business case contributions. In
addition, a special word of thanks goes to Bill Falloon, senior editor at John
Wiley & Sons, for his support and encouragement.
J. M.
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About the Author
D
r. Johnathan C. Mun is the founder and CEO of Real Options Valuation,
Inc., a consulting, training, and software development firm specializing in
real options, employee stock options, financial valuation, simulation, fore-
casting, optimization, and risk analysis located in northern California. He is
the creator of the Real Options Super Lattice Solver software, Risk Simula-
tor software, and Employee Stock Options Valuation software at the firm,
as well as the risk-analysis training DVD, and he also holds public seminars
on risk analysis and Certified Risk Analyst (CRA) programs. The Real Op-
tions Super Lattice Solver software showcased in this book supersedes the
previous Real Options Analysis Toolkit software, which he also developed.
He has also authored numerous other books including Real Options Analy-
sis: Tools and Techniques,first and second editions (Wiley 2003 and 2005),
Real Options Analysis Course: Business Cases (Wiley 2003), Applied Risk
Analysis: Moving Beyond Uncertainty (Wiley 2003), Valuing Employee
Stock Options(Wiley 2004), and others. His books and software are being
used around the world at top universities (including the Bern Institute in
Germany, Chung-Ang University in South Korea, Georgetown University,
ITESM in Mexico, Massachusetts Institute of Technology, New York Uni-
versity, Stockholm University in Sweden, University of the Andes in Chile,
University of Chile, University of Pennsylvania Wharton School, University
of York in the United Kingdom, and Edinburgh University in Scotland,
among others).
Dr. Mun is also currently a finance and economics professor and has
taught courses in financial management, investments, real options, econom-
ics, and statistics at the undergraduate and the graduate M.B.A. levels. He is
teaching and has taught at universities all over the world, from the U.S.
Naval Postgraduate School (Monterey, California) and University of Ap-
plied Sciences (Switzerland and Germany) as full professor, to Golden Gate
University (California) and St. Mary’s College (California), and has chaired
many graduate research thesis committees. He also teaches risk analysis, real
options analysis, and risk for managers public courses where participants
can obtain the Certified Risk Analyst (CRA) designation on completion of
the week-long program. He was formerly the vice president of analytics at
Decisioneering, Inc., where he headed up the development of real options
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