In the analysis of portfolio management, the initial work of Markowitz (1959) was directed towards finding the optimal weights in a portfolio. It was quickly realized that the decisions involved in building up a portfolio were less frequent than the decisions to modify existing portfolios. This is especially important when analyzing how profitable portfolio managers […]

Artificial Neural Networks (Finance)

Artificial neural networks (ANNs) are learning algorithms in the form of computer programs or hardware. ANNs are characterized by an architecture and a method of training. Network architecture refers to the way processing elements are connected and the direction of the signals exchanged. A processing element or unit is a node where input signals converge […]

Agency Theory (Finance)

When human interaction is viewed through the lens of the economist, it is presupposed that all individuals act in accordance with their self-interest. Moreover, individuals are assumed to be cognizant of the self-interest motivations of others and can form unbiased expectations about how these motivations will guide their behavior. Conflicts of interest naturally arise. These […]

Asset Pricing (Finance)

The modern theory of asset prices has its foundations in the portfolio selection theory initiated by Markowitz (1952). In a one-period framework Markowitz assumed that agents’ utilities, and hence the price they will pay, depend only on the means and variances of returns. This mean-variance model can be justified either on the grounds of quadratic […]

Bankruptcy (Finance)

A central tenet in economics is that competition drives markets toward a state of long-run equilibrium in which inefficient firms are eliminated and those remaining in existence produce at a minimum average cost. Consumers benefit from this state of affairs because goods and services are produced and sold at the lowest possible prices. A legal […]

Bid-Ask Spread (Finance)

Security dealers maintain a continuous presence in the market and stand ready to buy and sell securities immediately from impatient sellers and buyers. Dealers are willing to buy securities at a price slightly below the perceived equilibrium price (i.e. bid price) and sell securities immediately at a price slightly above the perceived equilibrium price (i.e. […]

Banks as Barrier Options (Finance)

A barrier option is an option which is initiated or extinguished if the underlying asset price hits a prespecified value. More specifically, a “down and out call” is a call option expiring worthless as soon as the value of the underlying asset hits a lower bound K, which is usually equal to or less than […]

Capital Adequacy (Finance)

Capital adequacy affects all corporate entities, but as a term it is most often used in discussing the position of firms in the financial sectors of the economy, and in particular whether firms have adequate capital to guard against the risks that they face. A balance needs to be struck between the often conflicting perspectives […]

Black-Scholes (Finance)

This is a famous equation for determining the price of an option, first discovered in 1972 by Fischer Black of Goldman Sachs and Myron Scholes of the University of Chicago and published in Black and Scholes (1973). The unique insight of this research was to use arbitrage in solving the option-pricing problem. Black and Scholes […]

Commodity Futures Volatility (Finance)

The definition of a commodity (by the Commodity Futures Trading Commission) includes all goods, articles, services, rights, and interest in which contracts for future delivery are dealt. However, another approach extracts the financial instruments (interest rate, equity, and foreign currency) leaving those assets more commonly referred to as commodities, that is agricultural (such as grains […]