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John Lee · Jow-Ran Chang · Lie-Jane Kao ·
Cheng-Few Lee

Essentials of
Excel VBA, Python,
and R
Volume II: Financial Derivatives, Risk Management
and Machine Learning
Second Edition
Essentials of Excel VBA, Python, and R
John Lee • Jow-Ran Chang •
Lie-Jane Kao • Cheng-Few Lee

Essentials of Excel VBA,

Python, and R
Volume II: Financial Derivatives, Risk
Management and Machine Learning
Second Edition

123
John Lee Jow-Ran Chang
Center for PBBEF Research Dept of Quantitative Finance
Morris Plains, NJ, USA National Tsing Hua University
Hsinchu, Taiwan
Lie-Jane Kao
College of Finance Cheng-Few Lee
Takming University of Science Rutgers School of Business
and Technology The State University of New Jersey
Taipei City, Taiwan North Brunswick, NJ, USA

ISBN 978-3-031-14282-6 ISBN 978-3-031-14283-3 (eBook)

https://doi.org/10.1007/978-3-031-14283-3

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature
Switzerland AG 2023
This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or
part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation,
broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and
retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter
developed.
The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not
imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and
regulations and therefore free for general use.
The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed
to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty,
expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been
made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional
affiliations.

This Springer imprint is published by the registered company Springer Nature Switzerland AG
The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland
Preface

In the new edition of this book, there are 49 chapters, and they are divided into two volumes.
Volume I, entitled “Microsoft Excel VBA, Python, and R For Financial Statistics and Portfolio
Analysis,” contains 26 chapters. Volume II entitled, “Microsoft Excel VBA, Python, and R
For Financial Derivatives, Financial Management, and Machine Learning,” contains 23
chapters. Volume I is divided into two parts. Part I Financial Statistics contains 21 chapters.
Part II Portfolio Analysis contains five chapters. Volume II is divided into five parts. Part I
Excel VBA contains three chapters. Part II Financial Derivatives contains six chapters. Part III
Applications of Python, Machine Learning for Financial Derivatives, and Risk Management
contains six chapters. Part IV Financial Management contains four chapters, and Part V
Applications of R Programs for Financial Analysis and Derivatives contains three chapters.
Part I of this volume discusses advanced applications of Microsoft Excel Programs.
Chapter 2 introduces Excel programming, Chap. 3 introduces VBA programming, and Chap. 4
discusses professional techniques used in Excel and Excel VBA techniques. There are six
chapters in Part II. Chapter 5 discusses the decision tree approach for the binomial option
pricing model, Chap. 6 discusses the Microsoft Excel approach to estimating alternative option
pricing models, Chap. 7 discusses how to use Excel to estimate implied variance, Chap. 8
discusses Greek letters and portfolio insurance, Chap. 9 discusses portfolio analysis and option
strategies, and Chap. 10 discusses simulation and its application.
There are six chapters in Part III, which describe applications of Python, machine learning for
financial analysis, and risk management. These six chapters are Linear Models for Regression
(Chap. 11), Kernel Linear Model (Chap. 12), Neural Networks and Deep Learning (Chap. 13),
Applications of Alternative Machine Learning Methods for Credit Card Default Forecasting
(Chap. 14), An Application of Deep Neural Networks for Predicting Credit Card Delinquencies
(Chap. 15), and Binomial/Trinomial Tree Option Pricing Using Python (Chap. 16).
Part IV shows how Excel can be used to perform financial management. Chapter 17 shows
how Excel can be used to perform financial ratio analysis, Chap. 18 shows how Excel can be
used to perform time value money analysis, Chap. 19 shows how Excel can be used to perform
capital budgeting under certainty and uncertainty, and Chap. 20 shows how Excel can be used
for financial planning and forecasting. Finally, Part V discusses applications of R programs for
financial analysis and derivatives. Chapter 21 discusses the theory and application of hedge
ratios. In this chapter, we show how the R program can be used for hedge ratios in terms of
three econometric methods. Chapter 22 discusses applications of a simultaneous equation in
finance research in terms of the R program. Finally, Chap. 23 discusses how to use the R
program to estimate the binomial option pricing model and the Black and Scholes option
pricing model.
In this volume, Chap. 14 was contributed by Huei-Wen Teng and Michael Lee. Chapter 15
was contributed by Ting Sun, and Chap. 22 was contributed by Fu-Lai Lin.
There are two possible applications of this volume:
A. to supplement financial derivative and risk management courses.
B. to teach students how to use Excel VBA, Python, and R to analyze financial derivatives
and perform risk management.

v
vi Preface

In sum, this book can be used by academic courses and for practitioners in the financial
industry. Finally, we appreciate the extensive help of our assistants Xiaoyi Huang and Natalie
Krawczyk.

Morris Plains, USA John Lee

Hsinchu, Taiwan Jow-Ran Chang
Taipei City, Taiwan Lie-Jane Kao
North Brunswick, USA Cheng-Few Lee
2021
Contents

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 Brief Description of Chap. 1 of Volume 1 . . . . . . . . . . . . . . . . . . . . . . . . 1
1.3 Structure of This Volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.3.1 Excel VBA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.3.2 Financial Derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.3.3 Applications of Python, Machine Learning for Financial
Derivatives, and Risk Management . . . . . . . . . . . . . . . . ....... 2
1.3.4 Financial Management . . . . . . . . . . . . . . . . . . . . . . . . . ....... 2
1.3.5 Applications of R Programs for Financial Analysis
and Derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....... 3
1.4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....... 3

Part I Excel VBA

2 Introduction to Excel Programming and Excel 365 Only Features . . . . . . . . . 7
2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2.2 Excel’s Macro Recorder . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2.3 Excel’s Visual Basic Editor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
2.4 Running an Excel Macro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
2.5 Adding Macro Code to a Workbook . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
2.6 Macro Button . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
2.7 Sub Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
2.8 Message Box and Programming Help . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
2.9 Excel 365 Only Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
2.9.1 Dynamic Arrays . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
2.9.2 Rich Data Types . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
2.9.3 STOCKHISTORY Function . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
2.10 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
3 Introduction to VBA Programming . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
3.2 Excel’s Object Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
3.3 Intellisense Menu . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
3.4 Object Browser . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
3.5 Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
3.6 Option Explicit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
3.7 Object Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
3.8 Functions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
3.9 Adding a Function Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
3.10 Specifying a Function Category . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

vii
viii Contents

3.11 Conditional Programming with the IF Statement . . . . . . . . . . . . . . . . . . . 61

3.12 For Loop . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
3.13 While Loop . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
3.14 Arrays . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
3.15 Option Base 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
3.16 Collections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
3.17 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
4 Professional Techniques Used in Excel and VBA . . . . . . . . . . . . . . . . . . . . . . 75
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
4.2 Finding the Range of a Table: CurrentRegion Property . . . . . . . . . . . . . . . 75
4.3 Offset Property of the Range Object . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
4.4 Resize Property of the Range Object . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
4.5 UsedRange Property of the Range Object . . . . . . . . . . . . . . . . . . . . . . . . 79
4.6 Go to Special Dialog Box of Excel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
4.7 Importing Column Data into Arrays . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
4.8 Importing Row Data into an Array . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
4.9 Transferring Data from an Array to a Range . . . . . . . . . . . . . . . . . . . . . . 94
4.10 Workbook Names . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
4.11 Dynamic Range Names . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98
4.12 Global Versus Local Workbook Names . . . . . . . . . . . . . . . . . . . . . . . . . . 102
4.13 List of All Files in a Directory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108
4.14 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

Part II Financial Derivatives

5 Binomial Option Pricing Model Decision Tree Approach . . . . . . . . . . . . . . . . 115
5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
5.2 Call and Put Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
5.3 Option Pricing—One Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117
5.4 Put Option Pricing—One Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
5.5 Option Pricing—Two Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119
5.6 Option Pricing—Four Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120
5.7 Using Microsoft Excel to Create the Binomial Option Call Trees . . . . . . . 121
5.8 American Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124
5.9 Alternative Tree Methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125
5.9.1 Cox, Ross, and Rubinstein . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125
5.9.2 Trinomial Tree . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127
5.9.3 Compare the Option Price Efficiency . . . . . . . . . . . . . . . . . . . . . 129
5.10 Retrieving Option Prices from Yahoo Finance . . . . . . . . . . . . . . . . . . . . . 130
5.11 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130
Appendix 5.1: EXCEL CODE—Binomial Option Pricing Model . . . . . . . . . . . . 131
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
6 Microsoft Excel Approach to Estimating Alternative Option Pricing
Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137
6.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137
6.2 Option Pricing Model for Individual Stock . . . . . . . . . . . . . . . . . . . . . . . 137
6.3 Option Pricing Model for Stock Indices . . . . . . . . . . . . . . . . . . . . . . . . . . 138
6.4 Option Pricing Model for Currencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
6.5 Futures Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140
Contents ix

6.6 Using Bivariate Normal Distribution Approach to Calculate

American Call Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
6.7 Black’s Approximation Method for American Option
with One Dividend Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148
6.8 American Call Option When Dividend Yield is Known . . . . . . . . . . . . . . 149
6.8.1 Theory and Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149
6.8.2 VBA Program for Calculating American Option When
Dividend Yield is Known . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150
6.9 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
Appendix 6.1: Bivariate Normal Distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
Appendix 6.2: Excel Program to Calculate the American Call Option
When Dividend Payments are Known . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156

7 Alternative Methods to Estimate Implied Variance . . . . . . . . . . . . . . . . . . . . 157

7.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
7.2 Excel Program to Estimate Implied Variance with Black–Scholes
Option Pricing Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
7.2.1 Black, Scholes, and Merton Model . . . . . . . . . . . . . . . . . . . . . . . 157
7.2.2 Approximating Linear Function for Implied Volatility . . . . . . . . . 158
7.2.3 Nonlinear Method for Implied Volatility . . . . . . . . . . . . . . . . . . . 160
7.3 Volatility Smile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167
7.4 Excel Program to Estimate Implied Variance with CEV Model . . . . . . . . . 169
7.5 WEBSERVICE Function . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174
7.6 Retrieving a Stock Price for a Specific Date . . . . . . . . . . . . . . . . . . . . . . 176
7.7 Calculated Holiday List . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177
7.8 Calculating Historical Volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178
7.9 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180
Appendix 7.1: Application of CEV Model to Forecasting Implied
Volatilities for Options on Index Futures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189

8 Greek Letters and Portfolio Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191

8.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191
8.2 Delta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191
8.2.1 Formula of Delta for Different Kinds of Stock Options . . . . . . . . 191
8.2.2 Excel Function of Delta for European Call Options . . . . . . . . . . . 192
8.2.3 Application of Delta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193
8.3 Theta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194
8.3.1 Formula of Theta for Different Kinds of Stock Options . . . . . . . . 194
8.3.2 Excel Function of Theta of the European Call Option . . . . . . . . . 194
8.3.3 Application of Theta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195
8.4 Gamma . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195
8.4.1 Formula of Gamma for Different Kinds of Stock Options . . . . . . 196
8.4.2 Excel Function of Gamma for European Call Options . . . . . . . . . 196
8.4.3 Application of Gamma . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197
8.5 Vega . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198
8.5.1 Formula of Vega for Different Kinds of Stock Options . . . . . . . . 198
8.5.2 Excel Function of Vega for European Call Options . . . . . . . . . . . 198
8.5.3 Application of Vega . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199
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8.6 Rho . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200

8.6.1 Formula of Rho for Different Kinds of Stock Options . . . . . . . . . 200
8.6.2 Excel Function of Rho for European Call Options . . . . . . . . . . . . 201
8.6.3 Application of Rho . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201
8.7 Formula of Sensitivity for Stock Options with Respect to Exercise
Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202
8.8 Relationship Between Delta, Theta, and Gamma . . . . . . . . . . . . . . . . . . . 202
8.9 Portfolio Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202
8.10 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203
9 Portfolio Analysis and Option Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205
9.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205
9.2 Three Alternative Methods to Solve the Simultaneous Equation . . . . . . . . 205
9.2.1 Substitution Method (Reference: Wikipedia) . . . . . . . . . . . . . . . . 205
9.2.2 Cramer’s Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205
9.2.3 Matrix Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
9.2.4 Excel Matrix Inversion and Multiplication . . . . . . . . . . . . . . . . . . 207
9.3 Markowitz Model for Portfolio Selection . . . . . . . . . . . . . . . . . . . . . . . . . 207
9.4 Option Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210
9.4.1 Long Straddle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210
9.4.2 Short Straddle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211
9.4.3 Long Vertical Spread . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213
9.4.4 Short Vertical Spread . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213
9.4.5 Protective Put . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213
9.4.6 Covered Call . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216
9.4.7 Collar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219
9.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222
Appendix 9.1: Monthly Rates of Returns for S&P500, IBM, and MSFT . . . . . . . 223
Appendix 9.2: Options Data for IBM (Stock Price = 141.34) on
July 23, 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225

10 Simulation and Its Application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227

10.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227
10.2 Monte Carlo Simulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227
10.3 Antithetic Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231
10.4 Quasi-Monte Carlo Simulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233
10.5 Application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237
10.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244
Appendix 10.1: EXCEL CODE—Share Price Paths . . . . . . . . . . . . . . . . . . . . . . 245
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246
On the Web . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246

Part III Applications of Python, Machine Learning for Financial Derivatives

and Risk Management
11 Linear Models for Regression . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249
11.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249
11.2 Loss Functions and Least Squares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249
11.3 Regularized Least Squares—Ridge and Lasso Regression . . . . . . . . . . . . . 250
11.4 Logistic Regression for Classification: A Discriminative Model . . . . . . . . 250
11.5 K-fold Cross-Validation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251
11.6 Types of Basis Function . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251
Contents xi

11.7 Accuracy Measures in Classification . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252

11.8 Python Programming Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252
Questions and Problems for Coding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259
12 Kernel Linear Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261
12.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261
12.2 Constructing Kernels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261
12.3 Kernel Regression (Nadaraya–Watson Model) . . . . . . . . . . . . . . . . . . . . . 261
12.4 Relevance Vector Machines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262
12.5 Gaussian Process for Regression . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263
12.6 Support Vector Machines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263
12.7 Python Programming . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264
12.8 Kernel Linear Model and Support Vector Machines . . . . . . . . . . . . . . . . . 265
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277
13 Neural Networks and Deep Learning Algorithm . . . . . . . . . . . . . . . . . . . . . . 279
13.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279
13.2 Feedforward Network Functions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279
13.3 Network Training: Error Backpropagation . . . . . . . . . . . . . . . . . . . . . . . . 280
13.4 Gradient Descent Optimization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282
13.5 Regularization in Neural Networks and Early Stopping . . . . . . . . . . . . . . 282
13.6 Deep Feedforward Network Versus Deep Convolutional Neural
Networks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283
13.7 Python Programing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 284
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 284

14 Alternative Machine Learning Methods for Credit Card Default

Forecasting* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285
14.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285
14.2 Literature Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285
14.3 Description of the Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287
14.4 Alternative Machine Learning Methods . . . . . . . . . . . . . . . . . . . . . . . . . . 287
14.4.1 k-Nearest Neighbors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287
14.4.2 Decision Trees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 288
14.4.3 Boosting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290
14.4.4 Support Vector Machines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290
14.4.5 Neural Networks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291
14.5 Study Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292
14.5.1 Data Preprocessing and Python Programming . . . . . . . . . . . . . . . 292
14.5.2 Tuning Optimal Parameters . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292
14.5.3 Learning Curves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294
14.6 Summary and Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295
Appendix 14.1: Python Codes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297
15 Deep Learning and Its Application to Credit Card Delinquency
Forecasting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 299
15.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 299
15.2 Literature Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 299
15.3 The Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300
15.3.1 Deep Learning in a Nutshell . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300
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15.3.2 Deep Learning Versus Conventional Machine Learning

Approaches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300
15.3.3 The Structure of a DNN and the Hyper-Parameters . . . . . . . . . . . 301
15.4 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303
15.5 Experimental Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304
15.5.1 Splitting the Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304
15.5.2 Tuning the Hyper-Parameters . . . . . . . . . . . . . . . . . . . . . . . . . . . 305
15.5.3 Techniques of Handling Data Imbalance . . . . . . . . . . . . . . . . . . . 306
15.6 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 306
15.6.1 The Predictor Importance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 306
15.6.2 The Predictive Result for Cross-Validation Sets . . . . . . . . . . . . . . 307
15.6.3 Prediction on Test Set . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 308
15.7 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309
Appendix 15.1: Variable Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 310
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311
16 Binomial/Trinomial Tree Option Pricing Using Python . . . . . . . . . . . . . . . . . 313
16.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313
16.2 European Option Pricing Using Binomial Tree Model . . . . . . . . . . . . . . . 313
16.2.1 European Option Pricing—Two Period . . . . . . . . . . . . . . . . . . . . 315
16.2.2 European Option Pricing—N Periods . . . . . . . . . . . . . . . . . . . . . 317
16.3 American Option Pricing Using Binomial Tree Model . . . . . . . . . . . . . . . 318
16.4 Alternative Tree Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320
16.4.1 Cox, Ross, and Rubinstein Model . . . . . . . . . . . . . . . . . . . . . . . . 320
16.4.2 Trinomial Tree . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321
16.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321
Appendix 16.1: Python Programming Code for Binomial Tree Option
Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323
Appendix 16.2: Python Programming Code for Trinomial Tree Option
Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 330
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 334

Part IV Financial Management

17 Financial Ratio Analysis and Its Applications . . . . . . . . . . . . . . . . . . . . . . . . 337
17.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 337
17.2 Financial Statements: A Brief Review . . . . . . . . . . . . . . . . . . . . . . . . . . . 337
17.2.1 Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 337
17.2.2 Statement of Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 339
17.2.3 Statement of Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 340
17.2.4 Statement of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 340
17.2.5 Interrelationship Among Four Financial Statements . . . . . . . . . . . 343
17.2.6 Annual Versus Quarterly Financial Data . . . . . . . . . . . . . . . . . . . 344
17.3 Static Ratio Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344
17.3.1 Static Determination of Financial Ratios . . . . . . . . . . . . . . . . . . . 344
17.4 Two Possible Methods to Estimate the Sustainable Growth Rate . . . . . . . . 348
17.5 DFL, DOL, and DCL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 349
17.5.1 Degree of Financial Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . 349
17.5.2 Operating Leverage and the Combined Effect . . . . . . . . . . . . . . . 350
17.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 354
Contents xiii

Appendix 17.1: Calculate 26 Financial Ratios with Excel . . . . . . . . . . . . . . . . . . 354

Appendix 17.2: Using Excel to Calculate Sustainable Growth Rate . . . . . . . . . . . 363
Appendix 17.3: How to Compute DOL, DFL, and DCL with Excel . . . . . . . . . . 364
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 368
18 Time Value of Money Determinations and Their Applications . . . . . . . . . . . . 369
18.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369
18.2 Basic Concepts of Present Values . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369
18.3 Foundation of Net Present Value Rules . . . . . . . . . . . . . . . . . . . . . . . . . . 370
18.4 Compounding and Discounting Processes . . . . . . . . . . . . . . . . . . . . . . . . 371
18.4.1 Single Payment Case—Future Values . . . . . . . . . . . . . . . . . . . . . 371
18.4.2 Continuous Compounding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 371
18.4.3 Single Payment Case—Present Values . . . . . . . . . . . . . . . . . . . . 372
18.4.4 Annuity Case—Present Values . . . . . . . . . . . . . . . . . . . . . . . . . . 373
18.4.5 Annuity Case—Future Values . . . . . . . . . . . . . . . . . . . . . . . . . . 373
18.4.6 Annual Percentage Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373
18.5 Present and Future Value Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 374
18.5.1 Future Value of a Dollar at the End of t Periods . . . . . . . . . . . . . 374
18.5.2 Future Value of a Dollar Continuously Compounded . . . . . . . . . . 375
18.5.3 Present Value of a Dollar Received t Periods in the Future . . . . . 376
18.5.4 Present Value of an Annuity of a Dollar Per Period . . . . . . . . . . . 377
18.6 Why Present Values Are Basic Tools for Financial Management
Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377
18.6.1 Managing in the Stockholders’ Interest . . . . . . . . . . . . . . . . . . . . 378
18.6.2 Productive Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379
18.7 Net Present Value and Internal Rate of Return . . . . . . . . . . . . . . . . . . . . . 381
18.8 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382
Appendix 18A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382
Appendix 18B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 384
Appendix 18C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 384
Appendix 18D: Applications of Excel for Calculating Time Value
of Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 386
Appendix 18E: Tables of Time Value of Money . . . . . . . . . . . . . . . . . . . . . . . . 390
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 401

19 Capital Budgeting Method Under Certainty and Uncertainty . . . . . . . . . . . . 403

19.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403
19.2 The Capital Budgeting Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403
19.2.1 Identification Phase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 404
19.2.2 Development Phase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405
19.2.3 Selection Phase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405
19.2.4 Control Phase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 406
19.3 Cash-Flow Evaluation of Alternative Investment Projects . . . . . . . . . . . . . 407
19.4 Alternative Capital-Budgeting Methods . . . . . . . . . . . . . . . . . . . . . . . . . . 409
19.4.1 Accounting Rate-of-Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409
19.4.2 Internal Rate-of-Return Method . . . . . . . . . . . . . . . . . . . . . . . . . 410
19.4.3 Payback Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410
19.4.4 Net Present Value Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410
19.4.5 Profitability Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411
19.5 Capital-Rationing Decision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411
19.5.1 Basic Concepts of Linear Programming . . . . . . . . . . . . . . . . . . . 412
19.5.2 Capital Rationing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 412
xiv Contents

19.6 The Statistical Distribution Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 413

19.6.1 Statistical Distribution of Cash Flow . . . . . . . . . . . . . . . . . . . . . . 414
19.7 Simulation Methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 416
19.7.1 Simulation Analysis and Capital Budgeting . . . . . . . . . . . . . . . . . 418
19.8 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 421
Appendix 19.1: Solving the Linear Program Model for Capital Rationing . . . . . . 422
Appendix 19.2: Decision Tree Method for Investment Decisions . . . . . . . . . . . . 429
Appendix 19.3: Hillier’s Statistical Distribution Method for Capital Budgeting
Under Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 430
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 431

20 Financial Analysis, Planning, and Forecasting . . . . . . . . . . . . . . . . . . . . . . . . 433

20.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 433
20.2 Procedures for Financial Planning and Analysis . . . . . . . . . . . . . . . . . . . . 433
20.3 The Algebraic Simultaneous Equations Approach to Financial
Planning and Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 435
20.4 The Linear Programming Approach to Financial Planning
and Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441
20.4.1 Profit Maximization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 442
20.4.2 Linear Programming and Capital Rationing . . . . . . . . . . . . . . . . . 443
20.4.3 Linear Programming Approach to Financial Planning . . . . . . . . . 444
20.5 The Econometric Approach to Financial Planning and Analysis . . . . . . . . 446
20.5.1 A Dynamic Adjustment of the Capital Budgeting Model . . . . . . . 446
20.5.2 Simplified Spies Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 447
20.6 Sensitivity Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 447
20.7 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 449
Appendix 20.1: The Simplex Algorithm for Capital Rationing . . . . . . . . . . . . . . 449
Appendix 20.2: Description of Parameter Inputs Used to Forecast Johnson
& Johnson’s Financial Statements and Share Price . . . . . . . . . . . . . . . . . . . . . . . 450
Appendix 20.3: Procedure of Using Excel to Implement the FinPlan
Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 451
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455

Part V Applications of R Programs for Financial Analysis and Derivatives

21 Hedge Ratio Estimation Methods and Their Applications . . . . . . . . . . . . . . . 459
21.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459
21.2 Alternative Theories for Deriving the Optimal Hedge Ratio . . . . . . . . . . . 460
21.2.1 Static Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 461
21.2.2 Dynamic Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 464
21.2.3 Case with Production and Alternative Investment
Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 464
21.3 Alternative Methods for Estimating the Optimal Hedge Ratio . . . . . . . . . . 465
21.3.1 Estimation of the Minimum-Variance (MV) Hedge Ratio . . . . . . . 465
21.3.2 Estimation of the Optimum Mean–Variance and Sharpe
Hedge Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 467
21.3.3 Estimation of the Maximum Expected Utility Hedge Ratio . . . . . . 467
21.3.4 Estimation of Mean Extended-Gini (MEG) Coefficient
Based Hedge Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 468
21.3.5 Estimation of Generalized Semivariance (GSV) Based
Hedge Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 468
21.4 Applications of OLS, GARCH, and CECM Models to Estimate
Optimal Hedge Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 468
Contents xv

21.5 Hedging Horizon, Maturity of Futures Contract, Data Frequency,

and Hedging Effectiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 470
21.6 Summary and Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 471
Appendix 21.1: Theoretical Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 473
Appendix 21.2: Empirical Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 475
Appendix 21.3: Monthly Data of S&P500 Index and Its Futures
(January 2005–August 2020) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 483
Appendix 21.4: Applications of R Language in Estimating the Optimal
Hedge Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488

22 Application of Simultaneous Equation in Finance Research: Methods

and Empirical Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491
22.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491
22.2 Literature Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491
22.3 Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 492
22.3.1 Application of GMM Estimation in the Linear Regression
Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 493
22.3.2 Applications of GMM Estimation in the Simultaneous
Equations Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 494
22.3.3 Weak Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 496
22.4 Applications in Investment, Financing, and Dividend Policy . . . . . . . . . . . 497
22.4.1 Model and Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 497
22.4.2 Results of Weak Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . 497
22.4.3 Empirical Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 498
22.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 505
Appendix 22.1: Data for Johnson & Johnson and IBM . . . . . . . . . . . . . . . . . . . 505
Appendix 22.2: Applications of R Language in Estimating the Parameters
of a System of Simultaneous Equations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 507
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 509

23 Three Alternative Programs to Estimate Binomial Option Pricing Model

and Black and Scholes Option Pricing Model . . . . . . . . . . . . . . . . . . . . . . . . 511
23.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 511
23.2 Microsoft Excel Program for the Binomial Tree Option Pricing
Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 511
23.3 Black and Scholes Option Pricing Model for Individual Stock . . . . . . . . . 512
23.4 Black and Scholes Option Pricing Model for Stock Indices . . . . . . . . . . . 514
23.5 Black and Scholes Option Pricing Model for Currencies . . . . . . . . . . . . . . 514
23.6 R Codes to Implement the Binomial Trees Option Pricing Model . . . . . . . 514
23.7 R Codes to Compute Option Prices by Black and Scholes Model . . . . . . . 519
23.8 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 519
Appendix 23.1: SAS Programming to Implement the Binomial Option
Trees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 519
Appendix 23.2: SAS Programming to ComputeOption Prices Using
Black and Scholes Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 521
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523
Other documents randomly have
different content
 MICHAEL ANGELO. [3]

Few lives of eminent men are harmonious; few that furnish, in all
the facts, an image corresponding with their fame. But all things
recorded of Michael Angelo Buonarotti agree together. He lived one
life; he pursued one career. He accomplished extraordinary works;
he uttered extraordinary words; and in this greatness was so little
eccentricity, so true was he to the laws of the human mind, that his
character and his works, like Sir Isaac Newton’s, seem rather a part
of nature than arbitrary productions of the human will. Especially we
venerate his moral fame. Whilst his name belongs to the highest
class of genius, his life contains in it no injurious influence. Every line
in his biography might be read to the human race with wholesome
effect. The means, the materials of his activity, were coarse enough
to be appreciated, being addressed for the most part to the eye; the
results, sublime and all innocent. A purity severe and even terrible
goes out from the lofty productions of his pencil and his chisel, and
again from the more perfect sculpture of his own life, which heals
and exalts. “He nothing common did, or mean,” and dying at the end
of near ninety years, had not yet become old, but was engaged in
executing his grand conceptions in the ineffaceable architecture of
St. Peter’s.
Above all men whose history we know, Michael Angelo presents
us with the perfect image of the artist. He is an eminent master in the
four fine arts, Painting, Sculpture, Architecture and Poetry. In three of
them by visible means, and in poetry by words, he strove to express
the Idea of Beauty. This idea possessed him and determined all his
activity. Beauty in the largest sense, beauty inward and outward,
comprehending grandeur as a part, and reaching to goodness as its
soul,—this to receive and this to impart, was his genius.
It is a happiness to find, amid the falsehood and griefs of the
human race, a soul at intervals born to behold and create only
beauty. So shall not the indescribable charm of the natural world, the
great spectacle of morn and evening which shut and open the most
disastrous day, want observers. The ancient Greeks called the world
Κόσμος, Beauty; a name which, in our artificial state of society,
sounds fanciful and impertinent. Yet, in proportion as man rises
above the servitude to wealth and a pursuit of mean pleasures, he
perceives that what is most real is most beautiful, and that, by the
contemplation of such objects, he is taught and exalted. This truth,
that perfect beauty and perfect goodness are one, was made known
to Michael Angelo; and we shall endeavor by sketches from his life
to show the direction and limitations of his search after this element.
In considering a life dedicated to the study of Beauty, it is natural
to inquire, what is Beauty? Can this charming element be so
abstracted by the human mind, as to become a distinct and
permanent object? Beauty cannot be defined. Like Truth, it is an
ultimate aim of the human being. It does not lie within the limits of
the understanding. “The nature of the beautiful,”—we gladly borrow
the language of Moritz, a German critic,—“consists herein, that
because the understanding in the presence of the beautiful cannot
ask, ‘Why is it beautiful?’ for that reason is it so. There is no standard
whereby the understanding can determine whether objects are
beautiful or otherwise. What other standard of the beautiful exists,
than the entire circuit of all harmonious proportions of the great
system of nature? All particular beauties scattered up and down in
nature are only so far beautiful, as they suggest more or less in
themselves this entire circuit of harmonious proportions.” This great
Whole, the understanding cannot embrace. Beauty may be felt. It
may be produced. But it cannot be defined.
The Italian artists sanction this view of beauty by describing it as il
più nell’ uno, “the many in one,” or multitude in unity, intimating that
what is truly beautiful seems related to all nature. A beautiful person
has a kind of universality, and appears to have truer conformity to all
pleasing objects in external nature than another. Every great work of
art seems to take up into itself the excellencies of all works, and to
present, as it were, a miniature of nature.
In relation to this element of Beauty, the minds of men divide
themselves into two classes. In the first place, all men have an
organization corresponding more or less to the entire system of
nature, and therefore a power of deriving pleasure from Beauty. This
is Taste. In the second place, certain minds, more closely
harmonized with nature, possess the power of abstracting Beauty
from things, and reproducing it in new forms, on any object to which
accident may determine their activity; as stone, canvas, song,
history. This is Art.
Since Beauty is thus an abstraction of the harmony and proportion
that reigns in all nature, it is therefore studied in nature, and not in
what does not exist. Hence the celebrated French maxim of
Rhetoric, Rien de beau que le vrai; “Nothing is beautiful but what is
true.” It has a much wider application than to Rhetoric; as wide,
namely, as the terms of the proposition admit. In art, Michael Angelo
is himself but a document or verification of this maxim. He labored to
express the beautiful, in the entire conviction that it was only to be
attained unto by knowledge of the true. The common eye is satisfied
with the surface on which it rests. The wise eye knows that it is
surface, and, if beautiful, only the result of interior harmonies, which,
to him who knows them, compose the image of higher beauty.
Moreover, he knew well that only by an understanding of the internal
mechanism can the outside be faithfully delineated. The walls of
houses are transparent to the architect. The symptoms disclose the
constitution to the physician; and to the artist it belongs by a better
knowledge of anatomy, and, within anatomy, of life and thought, to
acquire the power of true drawing. “The human form,” says Goethe,
“cannot be comprehended through seeing its surface. It must be
stripped of the muscles, its parts separated, its joints observed, its
divisions marked, its action and counter action learned; the hidden,
the reposing, the foundation of the apparent, must be searched, if
one would really see and imitate what moves as a beautiful
inseparable whole in living waves before the eye.” Michael Angelo
dedicated himself, from his childhood to his death, to a toilsome
observation of nature. The first anecdote recorded of him shows him
to be already on the right road. Granacci, a painter’s apprentice,
having lent him, when a boy, a print of St. Antony beaten by devils,
together with some colors and pencils, he went to the fish-market to
observe the form and color of fins and of the eyes of fish. Cardinal
Farnese one day found him, when an old man, walking alone in the
Coliseum, and expressed his surprise at finding him solitary amidst
the ruins; to which he replied, “I go yet to school that I may continue
to learn.” And one of the last drawings in his portfolio is a sublime
hint of his own feeling; for it is a sketch of an old man with a long
beard, in a go-cart, with an hour-glass before him; and the motto,
Ancora imparo, “I still learn.”
In this spirit he devoted himself to the study of anatomy for twelve
years; we ought to say rather, as long as he lived. The depth of his
knowledge in anatomy has no parallel among the artists of modern
times. Most of his designs, his contemporaries inform us, were made
with a pen, and in the style of an engraving on copper or wood; a
manner more expressive but not admitting of correction. When
Michael Angelo would begin a statue, he made first on paper the
skeleton; afterwards, upon another paper, the same figure clothed
with muscles. The studies of the statue of Christ in the Church of
Minerva at Rome, made in this manner, were long preserved.
Those who have never given attention to the arts of design, are
surprised that the artist should find so much to study in a fabric of
such limited parts and dimensions as the human body. But reflection
discloses evermore a closer analogy between the finite form and the
infinite inhabitant. Man is the highest, and indeed the only proper
object of plastic art. There needs no better proof of our instinctive
feeling of the immense expression of which the human figure is
capable, than the uniform tendency which the religion of every
country has betrayed towards Anthropomorphism, or attributing to
the Deity the human form. And behold the effect of this familiar
object every day! No acquaintance with the secrets of its
mechanism, no degrading views of human nature, not the most
swinish compost of mud and blood that was ever misnamed
philosophy, can avail to hinder us from doing involuntary reverence
to any exhibition of majesty or surpassing beauty in human clay.
Our knowledge of its highest expression we owe to the Fine Arts.
Not easily in this age will any man acquire by himself such
perceptions of the dignity or grace of the human frame, as the
student of art owes to the remains of Phidias, to the Apollo, the Jove,
the paintings and statues of Michael Angelo, and the works of
Canova. There are now in Italy, both on canvas and in marble, forms
and faces which the imagination is enriched by contemplating.
Goethe says that he is but half himself who has never seen the Juno
in the Rondanini palace at Rome. Seeing these works true to human
nature and yet superhuman, “we feel that we are greater than we
know.” Seeing these works, we appreciate the taste which led
Michael Angelo, against the taste and against the admonition of his
patrons, to cover the walls of churches with unclothed figures,
“improper,” says his biographer, “for the place, but proper for the
exhibition of all the pomp of his profound knowledge.”
The love of beauty which never passes beyond outline and color,
was too slight an object to occupy the powers of his genius. There is
a closer relation than is commonly thought between the fine arts and
the useful arts; and it is an essential fact in the history of Michael
Angelo, that his love of beauty is made solid and perfect by his deep
understanding of the mechanic arts. Architecture is the bond that
unites the elegant and the economical arts, and his skill in this is a
pledge of his capacity in both kinds. His Titanic handwriting in marble
and travertine is to be found in every part of Rome and Florence;
and even at Venice, on defective evidence, he is said to have given
the plan of the bridge of the Rialto. Nor was his a skill in ornament,
or confined to the outline and designs of towers and façades, but a
thorough acquaintance with all the secrets of the art, with all the
details of economy and strength.
When the Florentines united themselves with Venice, England and
France, to oppose the power of the Emperor Charles V., Michael
Angelo was appointed Military Architect and Engineer, to superintend
the erection of the necessary works. He visited Bologna to inspect its
celebrated fortifications, and, on his return, constructed a fortification
on the heights of San Miniato, which commands the city and
environs of Florence. On the 24th of October, 1529, the Prince of
Orange, general of Charles V., encamped on the hills surrounding
the city, and his first operation was to throw up a rampart to storm
the bastion of San Miniato. His design was frustrated by the
providence of Michael Angelo. Michael made such good resistance,
that the Prince directed the artillery to demolish the tower. The artist
hung mattresses of wool on the side exposed to the attack, and by
means of a bold projecting cornice, from which they were
suspended, a considerable space was left between them and the
wall. This simple expedient was sufficient, and the Prince was
obliged to turn his siege into a blockade.
After an active and successful service to the city for six months,
Michael Angelo was informed of a treachery that was ripening within
the walls. He communicated it to the government with his advice
upon it; but was mortified by receiving from the government
reproaches at his credulity and fear. He replied, “that it was useless
for him to take care of the walls, if they were determined not to take
care of themselves,” and he withdrew privately from the city to
Ferrara, and thence to Venice. The news of his departure
occasioned a general concern in Florence, and he was instantly
followed with apologies and importunities to return. He did so, and
resumed his office. On the 21st of March, 1530, the Prince of
Orange assaulted the city by storm. Michael Angelo is represented
as having ordered his defence so vigorously, that the Prince was
compelled to retire. By the treachery however of the general of the
Republic, Malatesta Baglioni, all his skill was rendered unavailing,
and the city capitulated on the 9th of August. The excellence of the
works constructed by our artist has been approved by Vauban, who
visited them and took a plan of them.
In Rome, Michael Angelo was consulted by Pope Paul III. in
building the fortifications of San Borgo. He built the stairs of Ara Celi
leading to the Church once the temple of Jupiter Capitolinus; he
arranged the piazza of the Capitol, and built its porticoes. He was
charged with rebuilding the Pons Palatinus over the Tiber. He
prepared, accordingly, a large quantity of blocks of travertine, and
was proceeding with the work, when, through the intervention of his
rivals, this work was taken from him and intrusted to Nanni di Bacio
Bigio, who plays but a pitiful part in Michael’s history. Nanni sold the
travertine, and filled up the piers with gravel at a small expense.
Michael Angelo made known his opinion, that the bridge could not
resist the force of the current; and, one day riding over it on
horseback, with his friend Vasari, he cried, “George, this bridge
trembles under us; let us ride faster lest it fall whilst we are upon it.”
It fell, five years after it was built, in 1557, and is still called the
“Broken Bridge.”
Versatility of talent in men of undoubted ability always awakens
the liveliest interest; and we observe with delight, that, besides the
sublimity and even extravagance of Michael Angelo, he possessed
an unexpected dexterity in minute mechanical contrivances. When
the Sistine Chapel was prepared for him that he might paint the
ceiling, he found the platform on which he was to work, suspended
by ropes which passed through the ceiling. Michael demanded of
San Gallo, the Pope’s architect, how these holes were to be repaired
in the picture? San Gallo replied; “That was for him to consider, for
the platform could be constructed in no other way.” Michael removed
the whole, and constructed a movable platform to rest and roll upon
the floor, which is believed to be the same simple contrivance which
is used in Rome, at this day, to repair the walls of churches. He gave
this model to a carpenter, who made it so profitable as to furnish a
dowry for his two daughters. He was so nice in tools, that he made
with his own hand the wimbles, the files, the rasps, the chisels and
all other irons and instruments which he needed in sculpture; and, in
painting, he not only mixed but ground his colors himself, trusting no
one.
And not only was this discoverer of Beauty, and its teacher among
men, rooted and grounded in those severe laws of practical skill,
which genius can never teach, and which must be learned by
practice alone, but he was one of the most industrious men that ever
lived. His diligence was so great that it is wonderful how he endured
its fatigues. The midnight battles, the forced marches, the winter
campaigns of Julius Cæsar or Charles XII. do not indicate greater
strength of body or of mind. He finished the gigantic painting of the
ceiling of the Sistine Chapel in twenty months, a fact which enlarges,
it has been said, the known powers of man. Indeed he toiled so
assiduously at this painful work, that, for a long time after, he was
unable to see any picture but by holding it over his head. A little
bread and wine was all his nourishment; and he told Vasari that he
often slept in his clothes, both because he was too weary to undress,
and because he would rise in the night and go immediately to work.
“I have found,” says his friend, “some of his designs in Florence,
where, whilst may be seen the greatness of his genius, it may also
be known that when he wished to take Minerva from the head of
Jove, there needed the hammer of Vulcan.” He used to make to a
single figure nine, ten, or twelve heads before he could satisfy
himself, seeking that there should be in the composition a certain
universal grace such as nature makes, saying, that “he needed to
have his compasses in his eye, and not in his hand, because the
hands work whilst the eye judges.” He was accustomed to say,
“Those figures alone are good, from which the labor is scraped off,
when the scaffolding is taken away.”
At near eighty years, he began in marble a group of four figures for
a dead Christ; because, he said, to exercise himself with the mallet
was good for his health.
And what did he accomplish? It does not fall within our design to
give an account of his works, yet for the sake of the completeness of
our sketch we will name the principal ones. Sculpture he called his
art, and to it he regretted afterwards he had not singly given himself.
The style of his paintings is monumental; and even his poetry
partakes of that character. In sculpture, his greatest work is the
statue of Moses in the Church of Pietro in Vincolo, in Rome. It is a
sitting statue of colossal size, and is designed to embody the
Hebrew Law. The lawgiver is supposed to gaze upon the
worshippers of the golden calf. The majestic wrath of the figure
daunts the beholder. In the Piazza del Gran Duca at Florence,
stands, in the open air, his David, about to hurl the stone at Goliah.
In the Church called the Minerva, at Rome, is his Christ; an object of
so much devotion to the people, that the right foot has been shod
with a brazen sandal to prevent it from being kissed away. In St.
Peter’s, is his Pietà, or dead Christ in the arms of his mother. In the
Mausoleum of the Medici at Florence, are the tombs of Lorenzo and
Cosmo, with the grand statues of Night and Day, and Aurora and
Twilight. Several statues of less fame, and bas-reliefs, are in Rome
and Florence and Paris.
His Paintings are in the Sistine Chapel, of which he first covered
the ceiling with the story of the creation, in successive
compartments, with the great series of the Prophets and Sibyls in
alternate tablets, and a series of greater and smaller fancy-pieces in
the lunettes. This is his capital work painted in fresco. Every one of
these pieces, every figure, every hand and foot and finger, is a study
of anatomy and design. Slighting the secondary arts of coloring, and
all the aids of graceful finish, he aimed exclusively, as a stern
designer, to express the vigor and magnificence of his conceptions.
Upon the wall, over the altar, is painted the Last Judgment.
Of his designs, the most celebrated is the cartoon representing
soldiers coming out in the bath and arming themselves; an incident
of the war of Pisa. The wonderful merit of this drawing, which
contrasts the extremes of relaxation and vigor, is conspicuous even
in the coarsest prints.
Of his genius for Architecture, it is sufficient to say that he built St.
Peter’s, an ornament of the earth. He said he would hang the
Pantheon in the air; and he redeemed his pledge by suspending that
vast cupola, without offence to grace or to stability, over the
astonished beholder. He did not live to complete the work; but is
there not something affecting in the spectacle of an old man, on the
verge of ninety years, carrying steadily onward with the heat and
determination of manhood, his poetic conceptions into progressive
execution, surmounting by the dignity of his purposes all obstacles
and all enmities, and only hindered by the limits of life from fulfilling
his designs? Very slowly came he, after months and years, to the
dome. At last he began to model it very small in wax. When it was
finished, he had it copied larger in wood, and by this model it was
built. Long after it was completed, and often since, to this day,
rumors are occasionally spread that it is giving way, and it is said to
have been injured by unskilful attempts to repair it. Benedict XIV.,
during one of these panics, sent for the architect Marchese Polini, to
come to Rome and examine it. Polini put an end to all the various
projects of repairs, by the satisfying sentence; “The cupola does not
start, and if it should start, nothing can be done but to pull it down.”
The impulse of his grand style was instantaneous upon his
contemporaries. Every stroke of his pencil moved the pencil in
Raphael’s hand. Raphael said, “I bless God I live in the times of
Michael Angelo.” Sir Joshua Reynolds, two centuries later, declared
to the British Institution, “I feel a self-congratulation in knowing
myself capable of such sensations as he intended to excite.”
A man of such habits and such deeds, made good his pretensions
to a perception and to delineation of external beauty. But inimitable
as his works are, his whole life confessed that his hand was all
inadequate to express his thought. “He alone,” he said, “is an artist
whose hands can perfectly execute what his mind has conceived;”
and such was his own mastery, that men said, “the marble was
flexible in his hands.” Yet, contemplating ever with love the idea of
absolute beauty, he was still dissatisfied with his own work. The
things proposed to him in his imagination were such, that, for not
being able with his hands to express so grand and terrible
conceptions, he often abandoned his work. For this reason he often
only blocked his statue. A little before he died, he burned a great
number of designs, sketches and cartoons made by him, being
impatient of their defects. Grace in living forms, except in very rare
instances, did not satisfy him. He never made but one portrait (a
cartoon of Messer Tommaso di Cavalieri), because he abhorred to
draw a likeness unless it were of infinite beauty.
Such was his devotion to art. But let no man suppose that the
images which his spirit worshipped were mere transcripts of external
grace, or that this profound soul was taken or holden in the chains of
superficial beauty. To him, of all men, it was transparent. Through it
he beheld the eternal spiritual beauty which ever clothes itself with
grand and graceful outlines, as its appropriate form. He called
eternal grace “the frail and weary weed, in which God dresses the
soul which he has called into Time.” “As from the fire, heat cannot be
divided, no more can beauty from the eternal.” He was conscious in
his efforts of higher aims than to address the eye. He sought,
through the eye, to reach the soul. Therefore, as, in the first place,
he sought to approach the Beautiful by the study of the True, so he
failed not to make the next step of progress, and to seek Beauty in
its highest form, that of Goodness. The sublimity of his art is in his
life. He did not only build a divine temple, and paint and carve saints
and prophets. He lived out the same inspiration. There is no spot
upon his fame. The fire and sanctity of his pencil breathe in his
words. When he was informed that Paul IV. desired he should paint
again the side of the chapel where the Last Judgment was painted,
because of the indecorous nudity of the figures, he replied, “Tell the
Pope that this is easily done. Let him reform the world and he will
find the pictures will reform themselves.” He saw clearly that if the
corrupt and vulgar eyes, that could see nothing but indecorum in his
terrific prophets and angels, could be purified as his own were pure,
they would only find occasion for devotion in the same figures. As he
refused to undo his work, Daniel di Volterra was employed to clothe
the figures; hence ludicrously called Il Braghettone. When the Pope
suggested to him that the chapel would be enriched if the figures
were ornamented with gold, Michael Angelo replied, “In those days,
gold was not worn; and the characters I have painted were neither
rich nor desirous of wealth, but holy men, with whom gold was an
object of contempt.”
Not until he was in the seventy-third year of his age, he undertook
the building of St. Peter’s. On the death of San Gallo, the architect of
the church, Paul III. first entreated, then commanded the aged artist,
to assume the charge of this great work, which though commenced
forty years before, was only commenced by Bramante, and ill
continued by San Gallo. Michael Angelo, who believed in his own
ability as a sculptor, but distrusted his capacity as an architect, at
first refused and then reluctantly complied. His heroic stipulation with
the Pope was worthy of the man and the work. He required that he
should be permitted to accept this work without any fee or reward,
because he undertook it as a religious act; and, furthermore, that he
should be absolute master of the whole design, free to depart from
the plans of San Gallo and to alter what had been already done.
This disinterestedness and spirit,—no fee and no interference,—
reminds one of the reward named by the ancient Persian. When
importuned to claim some compensation of the empire for the
important services he had rendered it, he demanded, “that he and
his should neither command nor obey, but should be free.” However,
as it was undertaken, so was it performed. When the Pope, delighted
with one of his chapels, sent him one hundred crowns of gold, as
one month’s wages, Michael sent them back. The Pope was angry,
but the artist was immovable. Amidst endless annoyances from the
envy and interest of the office-holders and agents in the work whom
he had displaced, he steadily ripened and executed his vast ideas.
The combined desire to fulfil, in everlasting stone, the conceptions of
his mind, and to complete his worthy offering to Almighty God,
sustained him through numberless vexations with unbroken spirit. In
answer to the importunate solicitations of the Duke of Tuscany that
he would come to Florence, he replies that “to leave St. Peter’s in
the state in which it now was, would be to ruin the structure, and
thereby be guilty of a great sin;” that he hoped he should shortly see
the execution of his plans brought to such a point that they could no
longer be interfered with, and this was the capital object of his
wishes, “if,” he adds, “I do not commit a great crime, by disappointing
the cormorants who are daily hoping to get rid of me.”
A natural fruit of the nobility of his spirit is his admiration of Dante,
to whom two of his sonnets are addressed. He shared Dante’s “deep
contempt of the vulgar, not of the simple inhabitants of lowly streets
or humble cottages, but of that sordid and abject crowd of all classes
and all places who obscure, as much as in them lies, every beam of
beauty in the universe.” In like manner, he possessed an intense
love of solitude. He lived alone, and never or very rarely took his
meals with any person. As will be supposed, he had a passion for
the country, and in old age speaks with extreme pleasure of his
residence with the hermits in the mountains of Spoleto; so much so
that he says he is “only half in Rome, since, truly, peace is only to be
found in the woods.” Traits of an almost savage independence mark
all his history. Although he was rich, he lived like a poor man, and
never would receive a present from any person; because it seemed
to him that if a man gave him anything, he was always obligated to
that individual. His friend Vasari mentions one occasion on which his
scruples were overcome. It seems that Michael was accustomed to
work at night with a pasteboard cap or helmet on his head, into
which he stuck a candle, that his work might be lighted and his
hands at liberty. Vasari observed that he did not use wax candles,
but a better sort made of the tallow of goats. He therefore sent him
four bundles of them, containing forty pounds. His servant brought
them after night-fall, and presented them to him. Michael Angelo
refused to receive them. “Look you, Messer Michael Angelo,” replied
the man, “these candles have well nigh broken my arm, and I will not
carry them back; but just here, before your door, is a spot of soft
mud, and they will stand upright in it very well, and there I will light
them all.”—“Put them down, then,” returned Michael, “since you shall
not make a bonfire at my gate.” Meantime he was liberal to profusion
to his old domestic Urbino, to whom he gave at one time two
thousand crowns, and made him rich in his service.
Michael Angelo was of that class of men who are too superior to
the multitude around them to command a full and perfect sympathy.
They stand in the attitude rather of appeal from their contemporaries
to their race. It has been the defect of some great men, that they did
not duly appreciate or did not confess the talents and virtues of
others, and so lacked one of the richest sources of happiness and
one of the best elements of humanity. This apathy perhaps happens
as often from preoccupied attention as from jealousy. It has been
supposed that artists more than others are liable to this defect. But
Michael Angelo’s praise on many works is to this day the stamp of
fame. Michael Angelo said of Masaccio’s pictures that when they
were first painted they must have been alive. He said of his
predecessor, the architect Bramante, that he laid the first stone of St.
Peter’s, clear, insulated, luminous, with fit design for a vast structure.
He often expressed his admiration of Cellini’s bust of Altoviti. He
loved to express admiration of Titian, of Donatello, of Ghiberti, of
Brunelleschi. And it is said that when he left Florence to go to Rome,
to build St. Peter’s, he turned his horse’s head on the last hill from
which the noble dome of the Cathedral (built by Brunelleschi) is
visible, and said, “Like you, I will not build; better than you I cannot.”
Indeed, as we have said, the reputation of many works of art now in
Italy derives a sanction from the tradition of his praise. It is more
commendation to say, “This was Michael Angelo’s favorite,” than to
say, “This was carried to Paris by Napoleon.” Michael, however, had
the philosophy to say, “Only an inventor can use the inventions of
others.”
There is yet one more trait in Michael Angelo’s history, which
humanizes his character without lessening its loftiness; this is his
platonic love. He was deeply enamored of the most accomplished
lady of the time, Vittoria Colonna, the widow of the Marquis di
Pescara, who, after the death of her husband, devoted herself to
letters, and to the writing of religious poetry. She was also an
admirer of his genius, and came to Rome repeatedly to see him. To
her his sonnets are addressed; and they all breathe a chaste and
divine regard, unparalleled in any amatory poetry except that of
Dante and Petrarch. They are founded on the thought that beauty is
the virtue of the body, as virtue is the beauty of the soul; that a
beautiful person is sent into the world as an image of the divine
beauty, not to provoke but to purify the sensual into an intellectual
and divine love. He enthrones his mistress as a benignant angel,
who is to refine and perfect his own character. Condivi, his friend,
has left this testimony; “I have often heard Michael Angelo reason
and discourse upon love, but never heard him speak otherwise than
upon platonic love. As for me, I am ignorant what Plato has said
upon this subject; but this I know very well, that, in a long intimacy, I
never heard from his mouth a single word that was not perfectly
decorous and having for its object to extinguish in youth every
improper desire, and that his own nature is a stranger to depravity.”
The poems themselves cannot be read without awakening
sentiments of virtue. An eloquent vindication of their philosophy may
be found in a paper by Signor Radici in the London “Retrospective
Review,” and, by the Italian scholar, in the Discourse of Benedetto
Varchi upon one sonnet of Michael Angelo, contained in the volume
of his poems published by Biagioli, from which, in substance, the
views of Radici are taken.
 Towards his end, there seems to have grown in him an invincible
appetite of dying, for he knew that his spirit could only enjoy
contentment after death. So vehement was this desire that, he says,
“my soul can no longer be appeased by the wonted seductions of
painting and sculpture.” A fine melancholy, not unrelieved by his
habitual heroism, pervades his thoughts on this subject. At the age
of eighty years, he wrote to Vasari, sending him various spiritual
sonnets he had written, and tells him he “is at the end of his life, that
he is careful where he bends his thoughts, that he sees it is already
twenty-four o’clock, and no fancy arose in his mind but death was
sculptured on it.” In conversing upon this subject with one of his
friends, that person remarked, that Michael might well grieve that
one who was incessant in his creative labors should have no
restoration. “No,” replied Michael, “it is nothing; for, if life pleases us,
death, being a work of the same master, ought not to displease us.”
But a nobler sentiment, uttered by him, is contained in his reply to a
letter of Vasari, who had informed him of the rejoicings made at the
house of his nephew Lionardo, at Florence, over the birth of another
Buonarotti. Michael admonishes him that “a man ought not to smile,
when all those around him weep; and that we ought not to show that
joy when a child is born, which should be reserved for the death of
one who has lived well.”
Amidst all these witnesses to his independence, his generosity, his
purity and his devotion, are we not authorized to say that this man
was penetrated with the love of the highest beauty, that is,
goodness; that his was a soul so enamored of grace, that it could not
stoop to meanness or depravity; that art was to him no means of
livelihood or road to fame, but the end of living, as it was the organ
through which he sought to suggest lessons of an unutterable
wisdom; that here was a man who lived to demonstrate that to the
human faculties, on every hand, worlds of grandeur and grace are
opened, which no profane eye and no indolent eye can behold, but
which to see and to enjoy, demands the severest discipline of all the
physical, intellectual and moral faculties of the individual?
The city of Florence, on the river Arno, still treasures the fame of
this man. There, his picture hangs in every window; there, the
tradition of his opinions meets the traveller in every spot. “Do you
see that statue of St. George? Michael Angelo asked it why it did not
speak.”—“Do you see this fine church of Santa Maria Novella? It is
that which Michael Angelo called ‘his bride.’”—“Look at these bronze
gates of the Baptistery, with their high reliefs, cast by Ghiberti five
hundred years ago. Michael Angelo said, ‘they were fit to be the
gates of Paradise.’”—Here is the church, the palace, the Laurentian
library he built. Here is his own house. In the church of Santa Croce
are his mortal remains. Whilst he was yet alive, he asked that he
might be buried in that church, in such a spot that the dome of the
cathedral might be visible from his tomb when the doors of the
church stood open. And there and so is he laid. The innumerable
pilgrims whom the genius of Italy draws to the city, duly visit this
church, which is to Florence what Westminster Abbey is to England.
There, near the tomb of Nicholas Machiavelli, the historian and
philosopher; of Galileo, the great-hearted astronomer; of Boccaccio,
and of Alfieri, stands the monument of Michael Angelo Buonarotti.
Three significant garlands are sculptured on the tomb; they should
be four, but that his countrymen feared their own partiality. The
forehead of the bust, esteemed a faithful likeness, is furrowed with
eight deep wrinkles one above another. The traveller from a distant
continent, who gazes on that marble brow, feels that he is not a
stranger in the foreign church; for the great name of Michael Angelo
sounds hospitably in his ear. He was not a citizen of any country; he
belonged to the human race; he was a brother and a friend to all who
acknowledge the beauty that beams in universal nature, and who
seek by labor and self-denial to approach its source in perfect
goodness.

FOOTNOTES:

[3] Reprinted from the North American Review, June, 1837.

 MILTON.

I framed his tongue to music,

I armed his hand with skill,
I moulded his face to beauty,
And his heart the throne of will.
 MILTON. [4]

The discovery of the lost work of Milton, the treatise “Of the
Christian Doctrine,” in 1823, drew a sudden attention to his name.
For a short time the literary journals were filled with disquisitions on
his genius; new editions of his works, and new compilations of his
life, were published. But the new-found book having in itself less
attraction than any other work of Milton, the curiosity of the public as
quickly subsided, and left the poet to the enjoyment of his permanent
fame, or to such increase or abatement of it only as is incidental to a
sublime genius, quite independent of the momentary challenge of
universal attention to his claims.
But if the new and temporary renown of the poet is silent again, it
is nevertheless true that he has gained, in this age, some increase of
permanent praise. The fame of a great man is not rigid and stony like
his bust. It changes with time. It needs time to give it due
perspective. It was very easy to remark an altered tone in the
criticism when Milton re-appeared as an author, fifteen years ago,
from any that had been bestowed on the same subject before. It
implied merit indisputable and illustrious; yet so near to the modern
mind as to be still alive and life-giving. The aspect of Milton, to this
generation, will be part of the history of the nineteenth century. There
is no name in English literature between his age and ours that rises
into any approach to his own. And as a man’s fame, of course,
characterizes those who give it, as much as him who receives it, the
new criticism indicated a change in the public taste, and a change
which the poet himself might claim to have wrought.
The reputation of Milton had already undergone one or two
revolutions long anterior to its recent aspects. In his lifetime, he was
little or not at all known as a poet, but obtained great respect from
his contemporaries as an accomplished scholar and a formidable
pamphleteer. His poem fell unregarded among his countrymen. His
prose writings, especially the “Defence of the English People,” seem
to have been read with avidity. These tracts are remarkable
compositions. They are earnest, spiritual, rich with allusion, sparkling
with innumerable ornaments; but, as writings designed to gain a
practical point, they fail. They are not effective, like similar
productions of Swift and Burke; or, like what became also
controversial tracts, several masterly speeches in the history of the
American Congress. Milton seldom deigns a glance at the obstacles
that are to be overcome before that which he proposes can be done.
There is no attempt to conciliate,—no mediate, no preparatory
course suggested,—but, peremptory and impassioned, he demands,
on the instant, an ideal justice. Therein they are discriminated from
modern writings, in which a regard to the actual is all but universal.
Their rhetorical excellence must also suffer some deduction. They
have no perfectness. These writings are wonderful for the truth, the
learning, the subtilty and pomp of the language; but the whole is
sacrificed to the particular. Eager to do fit justice to each thought, he
does not subordinate it so as to project the main argument. He writes
whilst he is heated; the piece shows all the rambles and resources of
indignation, but he has never integrated the parts of the argument in
his mind. The reader is fatigued with admiration, but is not yet
master of the subject.
Two of his pieces may be excepted from this description, one for
its faults, the other for its excellence. The “Defence of the People of
England,” on which his contemporary fame was founded, is, when
divested of its pure Latinity, the worst of his works. Only its general
aim, and a few elevated passages, can save it. We could be well
content, if the flames to which it was condemned at Paris, at
Toulouse, and at London, had utterly consumed it. The lover of his
genius will always regret that he should not have taken counsel of
his own lofty heart at this, as at other times, and have written from
the deep convictions of love and right, which are the foundations of
civil liberty. There is little poetry or prophecy in this mean and ribald
scolding. To insult Salmasius, not to acquit England, is the main
design. What under heaven had Madame de Saumaise, or the
manner of living of Saumaise, or Salmasius, or his blunders of
grammar, or his niceties of diction, to do with the solemn question
whether Charles Stuart had been rightly slain? Though it evinces
learning and critical skill, yet, as an historical argument, it cannot be
valued with similar disquisitions of Robertson and Hallam, and even
less celebrated scholars. But, when he comes to speak of the reason
of the thing, then he always recovers himself. The voice of the mob
is silent, and Milton speaks. And the peroration, in which he implores
his countrymen to refute this adversary by their great deeds, is in a
just spirit. The other piece is his “Areopagitica,” the discourse,
addressed to the Parliament, in favor of removing the censorship of
the press; the most splendid of his prose works. It is, as Luther said
of one of Melancthon’s writings, “alive, hath hands and feet,—and
not like Erasmus’s sentences, which were made, not grown.” The
weight of the thought is equalled by the vivacity of the expression,
and it cheers as well as teaches. This tract is far the best known and
the most read of all, and is still a magazine of reasons for the
freedom of the press. It is valuable in history as an argument
addressed to a government to produce a practical end, and plainly
presupposes a very peculiar state of society.
But deeply as that peculiar state of society, in which and for which
Milton wrote, has engraved itself in the remembrance of the world, it
shares the destiny which overtakes everything local and personal in
nature; and the accidental facts on which a battle of principles was
fought have already passed, or are fast passing, into oblivion. We
have lost all interest in Milton as the redoubted disputant of a sect;
but by his own innate worth this man has steadily risen in the world’s
reverence, and occupies a more imposing place in the mind of men
at this hour than ever before.