CONTENTS -- Introduction -- Practitioner's Digest -- Chapter 1 Design of Financial Systems: Towards a Synthesis of Function and Structure Robert C. Merton and Zvi Bodie -- 1 Introduction -- 2 On the Impact of Finance Science on Finance Practice -- 3 The Challenge to Neoclassical Finance -- 4 The Functional Synthesis -- 4.1 Example 1. Transaction Costs and Option Pricing -- 4.2 Example 2. Continuous-Time Portfolio Theory -- 4.3 Example 3. Irrational Pessimism/Optimism -- 4.4 Example 4. Home Bias -- 4.5 Example 5. Regret Aversions34 -- 4.6 Example 6. Organizational Design -- 4.7 Example 7. Don't Change Behavior -- Solve with Institutions -- 4.8 Example 8. Sociological Elements of Behavioral Finance40 -- 5 Elements of Functional and Structural Finance -- 5.1 Functions are the "Anchors" -- 5.2 The Point of Departure is the Neoclassical Paradigm -- 5.3 Theory as a Predictor of Practice -- 5.4 Institutional Rationality Versus Individual Irrationality -- 5.5 Synthesis of Public and Private Finance -- 5.6 The Financial Innovation Spiral 47 -- 6 Conclusion: Finance and Economic Growth -- Notes -- References -- Chapter 2 Asset/Liability Management and Enterprise Risk Management of an Insurer Thomas S. Y. Ho -- 1 Risk Management Practice for Life Companies -- 1.1 Cash Flow Testing -- 1.2 Total Return Approach -- 1.2.1 Fair valuation of liabilities -- 1.2.2 Liability benchmark -- 1.2.3 Asset benchmarks -- 1.2.3.1 Investment guidelines -- 1.2.3.2 Constructing the asset benchmark -- 1.2.3.3 The sector benchmark -- 1.2.4 Return attribution -- 2 Risk Management Practice for General Insurance Companies: Dynamic Financial Analysis -- 3 The Corporate Model -- 3.1 The Sales Volume -- 3.2 Asset Economic Value and the GAAP Balance Sheet Statements -- 3.3 Modeling the Discount Rate of the Businesses -- 3.4 The Objective of Risk Management -- 4 Conclusions.

Acknowledgments -- References -- Chapter 3 It's 11 pm-Do You Know Where Your Liquidity Is? The Mean-Variance-Liquidity Frontier AndrewW. Lo, Constantin Petrov and Martin Wierzbicki -- 1 Introduction -- 2 Liquidity Metrics -- 2.1 Liquidity Metrics for Individual Securities -- 2.2 Liquidity Metrics for Portfolios -- 2.3 Qualifications -- 3 Liquidity-Optimized Portfolios -- 3.1 Liquidity Filters -- 3.2 Liquidity Constraints -- 3.3 Mean-Variance-Liquidity Objective Function -- 4 An Empirical Example -- 4.1 Data Summary -- 4.2 The Liquidity-Filtered Frontier -- 4.3 The Liquidity-Constrained Frontier -- 4.4 The Mean-Variance-Liquidity Frontier -- 5 Conclusions -- Appendix A -- A.1 Matlab Loeb Function tloeb -- A.2 Sampling Procedure -- Acknowledgments -- Notes -- References -- Chapter 4 Time Diversification Jack L. Treynor -- 1 A Parable -- 2 The Buy-and-Hold Investor -- 3 Time Diversification -- 4 Risk and Reward -- 5 Terminal Dollars -- 6 Constant Dollar Risk -- 7 Inflation -- 8 An Approximation -- 9 The Role of Beta -- 10 Accuracy of the Approximation -- 11 Rebalancing -- 12 The Evidence -- 13 Implementing the Approximation Portfolio -- 14 Should Risk Decline with Age? -- Notes -- Chapter 5 A Practical Framework for Portfolio Choice Richard O. Michaud -- 1 Classical Versus Resampled Efficiency -- 2 Portfolio Optimality Criteria -- 2.1 Utility Functions -- 2.2 Short- and Long-Term Return Probabilities -- 2.3 The Long-Term Geometric Mean Criterion -- 2.4 Merton-Samuelson Critique of the Long-Term Geometric Mean Criterion -- 3 Properties of the Geometric Mean Distribution -- 3.1 Horizon Dependence -- 3.2 The Geometric Mean Normal Distribution Approximation -- 3.3 The Expected Geometric Mean and Median TerminalWealth -- 3.4 The MV of Geometric Mean Return -- 4 Financial Planning and Portfolio Choice -- 4.1 Monte Carlo Financial Planning.

4.2 Geometric Mean Financial Planning -- 4.3 Monte Carlo Versus Geometric Mean Financial Planning -- 5 Geometric Mean Applications to Asset Management -- 5.1 The Critical Point and Maximum Growth Rates -- 6 Resolving Financial Paradoxes with Geometric Mean Analysis -- 6.1 CAPM and the Limits of High Beta Portfolios -- 6.2 Taxes and the Benefits of Diversi.ed Funds -- 6.3 Asset Allocation Strategies that Lead to Ruin40 -- 7 The Special Case of Defined Benefit Pension Plan Asset Allocation -- 7.1 Economic Nature of Defined Benefit Pension Plans -- 7.2 A Cautionary Tale for Pension Fund Asset Allocation -- 7.3 Economic Liabilities and Asset-Liability Asset Allocation -- 8 Conclusion -- Appendix A -- A.1 Additional Critical Point Issues -- Acknowledgment -- Notes -- References -- Chapter 6 A Markov Chain Monte Carlo Method for Derivative Pricing and Risk Assessment Sanjiv R. Das and Alistair Sinclair -- 1 Overview -- 2 Basic Ideas -- 3 The Algorithm -- 3.1 Set-Up -- 3.2 Overall Structure -- 3.3 Recursive Estimation -- 3.4 Random Sampling -- 3.5 Overall Running Time -- 4 An Application: Barrier Options -- 5 Discussion -- Appendix A: Properties of the Algorithm -- A.1 Discussion of Variance -- A.2 Discussion of Property (1) -- A.3 Discussion of Property (2) -- Notes -- References -- Chapter 7 Active Risk and Information Ratio Edward Qian and Ronald Hua -- 1 Introduction -- 2 Notations and Main Results -- 3 Cross-Sectional IC and Single-Period Excess Return -- 4 Information Ratio -- 4.1 The Simple Case -- 4.2 A Better Estimation of IR -- 5 Empirical Examinations -- 5.1 The Data -- 5.2 The Russell 3000 Universe -- 5.3 Information Content of Strategy Risk: An Example -- 5.4 Consistent Estimator of Active Risk -- 5.5 Persistence of Strategy Risk -- 6 Conclusion -- Appendix A: Optimal Active Weights and Excess Return -- Appendix B: The Information Ratio.

Notes -- References -- Chapter 8 The Year-End Price of Risk in a Market for Liquidity Mark D. Griffiths and Drew B.Winters -- 1 Introduction -- 2 Data and Methods -- 2.1 Data -- 2.2 Methods -- 3 Analysis -- 3.1 Descriptive Analysis -- 3.2 Regression Analysis -- 3.3 Discussion About Market Participants -- 4 Conclusion -- Acknowledgments -- Notes -- References -- Chapter 9 Resampled Frontiers versus Diffuse Bayes: An Experiment Harry M. Markowitz and Nilufer Usmen -- 1 Introduction -- 2 The Referee and The Game -- 3 The Michaud Player -- 4 The Diffuse Bayes Player -- 4.1 Basics -- 4.2 Diffuse Priors -- 4.3 Importance Sampling -- 5 Results -- 6 Questions -- 7 Conclusions -- Acknowledgment -- Notes -- References -- Chapter 10 Fund Managers May Cause Their Benchmarks to be Priced "Risks" Michael Stutzer -- 1 Introduction -- 2 Conventional Mean-Variance versus TEV Investing -- 2.1 Description Versus Prescription -- 3 Capital Market Equilibrium -- 4 Some Empirical Evidence -- 5 Conclusion -- Acknowledgment -- Notes -- References.