The present third edition of The Statistical Mechanics of Financial Markets is published only four years after the ?rst edition. The success of the book highlights the interest in a summary of the broad research activities on the application of statistical physics to ?nancial markets. I am very grateful to readers and reviewers for their positive reception and comments. Why then prepare a new edition instead of only reprinting and correcting the second edition? The new edition has been signi?cantly expanded, giving it a more pr- tical twist towards banking. The most important extensions are due to my practical experience as a risk manager in the German Savings Banks' As- ciation (DSGV): Two new chapters on risk management and on the closely related topic of economic and regulatory capital for ?nancial institutions, - spectively, have been added. The chapter on risk management contains both the basics as well as advanced topics, e. g. coherent risk measures, which have not yet reached the statistical physics community interested in ?nancial m- kets. Similarly, it is surprising how little research by academic physicists has appeared on topics relating to Basel II. Basel II is the new capital adequacy framework which will set the standards in risk management in many co- tries for the years to come. Basel II is responsible for many job openings in banks for which physicists are extemely well quali?ed. For these reasons, an outline of Basel II takes a major part of the chapter on capital. Basic Information on Capital Markets.- Random Walks in Finance and Physics.- The Black-Scholes Theory of Option Prices.- Scaling in Financial Data and in Physics.- Turbulence and Foreign Exchange Markets.- Derivative Pricing Beyond Black-Scholes.- Microscopic Market Models.- Theory of Stock Exchange Crashes.- Risk Management.- Economic and Regulatory Capital for Financial Institutions. The third edition of this highly praised reference offers new chapters on the basic notions and tools of risk management, and capital requirements for financial institutions, including an overview of the new Basel II capital framework which may well set the risk management standards in scores of countries for years to come. Using empirical financial data and analogies to physical models such as fluid flows, turbulence, or superdiffusion, the book develops a more accurate description of financial markets based on random walks. This approach permits the formulation of novel methods for derivative pricing and risk management.
From the reviews of the third edition:
"An excellent job of integrating many of the most important themes from econophysics in a relatively small volume. ... The book serves its purpose, as a textbook on econophysics, superbly and one can tell that it developed from a course of lectures. The book is written with extreme clarity and an excellent pedagogical style. For philosophers who wish to acquaint themselves with the field of econophysics (beyond a superficial level), this is the book to invest in." (Dean Rickles, Studies in History and Philosophy of Modern Physics, Vol. 38, 2007)
