Most helpful critical review
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A non-quantitative finance book.
on January 4, 2004
Several earlier reviews of Janet Tavakoli's book praise it for thoroughly explaining various types of credit derivatives and effectively analyzing such issues as marking-to-market credit derivatives. However, many of these reviews do a disservice to potential book buyers by failing to point out deficiencies that become clear just by superficially browsing through the book:
1. Tavakoli rightly cautions against using neat pricing formulas that make unwarranted assumptions about critical variables like default probabilities, but her book appears to contain virtually no statistical analysis or pricing models of its own, and indeed, very little quantitative analysis at all.
2. In lieu of quantitative analysis, Tavakoli often substitutes assertions too fuzzy to have a testable meaning, such as "The market doesn't reveal its secrets; it responds to a method of questioning." She also has a tendency to fill up space with bromides like "A firm with the ability to manage risk and to exploit timely marketing information and good marketing distribution has the greatest chance of reward."
3. Her book also contains gratuitous and unprofessional asides that have no place in a text on credit derivatives, such as her contentious conversations with other traders, and her explanation of alleged extensive Jewish influence in international banking. She claims that:
"The international Jewish community was instrumental in the formation of early banking practices...The Jewish people had a means of censuring members of their community who broke the law through social and commercial ostracism...the Jewish people had their first international 'sovereign' state visible outside of their community in the form of the first standards for international banking."
4. When she does briefly discuss statistical models, Tavakoli can be imprecise, wordy, and uncertain, as when she talks about the implied volatility of options in the context of using historical data to predict credit risk: "If we want to construct a probability distribution of the terminal value of a security due to interest rate and credit moves, we could canvas the market for a menu of puts and calls in, at, and out of the money for the relevant time horizon. From this we can not only back out implied volatilities, but also..."
Readers who know that the option price is a one-to-one function of volatility (among other variables) in various standard pricing models, will understand what Tavakoli is referring to here, but a phrase like "backing out implied volatilities" is not an adequate explanation of anything.
In summary, although Ms. Tavakoli deals with a large number of essential topics, including credit linked notes, exotic swaps, and emerging markets, she does so heuristically, with little quantitative justification, and her book is burdened by too much inappropriate and superfluous material.