We present a theory of option pricing and hedging, designed to address non-perfect arbitrage, market friction and the presence of ‘fat’ tails. An implied volatility ‘smile’ is predicted. We give precise estimates of the residual risk associated with optimal (but imperfect) hedging. Accepted for publication in Risk Magazine (December 1995).

We conduct an experiment of two player bargaining in which the payoff to one player is subject to ex-post risk, while the other player receives a fixed payment, effectively making the player exposed to risk a residual claimant. Contrary to intuition, recent theoretical work argues that exposure to risk may actually be beneficial to the residual claimant, and we test this in a controlled lab exp...

When risk managers develop firm-wide measures of risk, the efforts can impose substantial costs both of developing information systems and, on an ongoing basis, of computation and aggregation. These costs can lead risk managers to base risk measures on a set of risk factors (including asset prices) of lower dimension than the dimension of underlying sources of risk. Such truncation of the set o...

Safety is typically demonstrated by identifying hazards, mitigating those hazards, and then by showing that the remaining risk is acceptable. This paper begins by setting out some principles for assessing tests of risk acceptability. It then categorises and examines existing methods of testing for risk acceptability against those principles, and finds that they fall short. A new measure of risk...

Measures of residual risk are developed as extension of measures of risk. They view a random variable of interest in concert with an auxiliary random vector that helps to manage, predict, and mitigate the risk in the original variable. Residual risk can be exemplified as a quantification of the improved situation faced by a hedging investor compared to that of a single-asset investor, but the n...

The R3i Foundation (Residual Risk Reduction Initiative), an independent, multinational and academic organization, is conducting the REALIST (Residual Risk, Lipids and Standard Therapies) study in 40 centers in different countries. This is a retrospective epidemiological study, designed to provide new data on the residual risk of major coronary events attributable to lipid abnormalities in patie...