Sunday, February 20, 2005

Finance for beginners

I recently discovered the Web site of John Norstad. According to his fascinating bio, John was an Iowa boy like me, who had a little too much interest in math when growing up. He now works in software development at Northwestern University, but has taken time out recently to write a number of expository papers on topics in modern finance, ranging from portfolio theory to options pricing.

Particularly nice is his note on "two-state options," a kind of toy-model world that helps develop intuition. One thing that always used to bother me was how the price of an option could really be independent of the assumed "drift term" in the Black-Scholes model (you can find this debated by real practitioners here). An explicit model in which one can replicate the derivative using cash and shares of the underlying security makes this more transparent. The deep insight is that all expectations about future returns on the underlying are contained in the instantaneous price. This also clarifies the observation that derivatives can be priced in a risk-neutral way, as I mentioned in my post on path integrals.

I haven't looked at all of his papers, but they seem just right for someone with a background in math or physics who wants a clear, concise, but theoretically sophisticated introduction to this subject. I usually tell people to read John Hull's introductory textbook, but I think a stop at Norstad's site might be very worthwhile.


Anonymous said...

My, this is nice. I will play :)


Anonymous said...

Aside: Japan is changing.

A Samurai And Japan Get Samba Night Fever

OSAKA, Japan - Perhaps it was the equivalent of Americans waking up one morning to find John Wayne transformed into the Cowboy of the Village People.

For 25 years, on a Japanese television series called "The Violent Shogun," Ken Matsudaira played an 18th-century samurai who embodied Japan's idealized masculinity: strong, selfless, interested in neither women nor money, quick to dispense cold justice with his sword and a single order, "Punish!"

So closely identified had Mr. Matsudaira become with this pop culture hero that it came as a shock when the Japanese found out recently that for the last decade (and hidden mostly out of sight), he had been dancing the samba on stage in glittering gold and purple kimonos, emitting animalistic cries and thrusting his hips. His sword replaced by a coterie of female dancers and a revolving disco ball, he told his fans that in these dark days in Japan, samba was the only thing to do and sang: "Samba! Viva! Samba! Matsuken Samba! Olé!"

The metamorphosis of Mr. Matsudaira, now 51, into the singing samurai of his revuelike show, "Matsuken Samba II," caught on wildly in a country where the idealized image of Japanese masculinity has changed drastically in recent years, both in pop culture and in the real world, from stern to soft....


Anonymous said...

John Norstad is quite a teacher. This is well done indeed, as far as I have gone but I will go much further. Nice.


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