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The CAPM world of equity and debt is supported principally by index mutual funds
and a banking system that stands ready to
lend or borrow at the risk-free rate in order
to facilitate dynamic risk control as equity
prices fluctuate. Financial engineering can
help by devising algorithms for efficient
operation of these key institutions.
Portfolio insurance, for example, already
offers the possibility of reducing trading
costs by directly linking up agents with
differing risk tolerance, those who want to
sell as price rises with those who want
to buy. Fischer thought that financial
engineering could go further by devising
additional derivative contracts to implement desirable dynamic trading strategies.
One additional institution, the exchange
itself, is also central in a CAPM world.
REFERENCES
Black, Fischer. 1997. Fischer Blacks
Brave New World. Risk. 10(11): 44-45.
Black, Fischer. 1995. The Many Faces of
Derivatives. Foreword to Handbook of
Equity Derivatives, edited by Jack Francis,
William Toy and J. Gregg Whittaker. New
York: John Wiley & Sons.
Black, Fischer. 1995. Hedging, Speculation
and Systemic Risk. Journal of Derivatives
(Summer): 6-8.
Black, Fischer. 1995. Exploring General
Equilibrium. Cambridge, Massachusetts:
MIT Press.
Mehrling, Perry. 2005. Fischer Black and the
Revolutionary Idea of Finance. Hoboken,
New Jersey: John Wiley & Sons.
From the November/December 2005 Special Report
in Financial Engineering News, On the Frontiers
of Financial Engineering and Risk Management.
See http://www.fenews.com/fen46/front-sr/ for the
complete Special Report. Copyright 2005 Financial
Engineering News, all rights reserved.