FIN513 Asset Pricing Theory II (expired)

• Topics

  The course starts with a financial market in a continuous time framework, where the

  Black/Scholes model is typically taken as the prime example. The "modern" martingale theory is

  made use of in characterizing absence of arbitrage, in a fairly simple way, for continuous

  diffusion, or Ito-processes.

  • After the introduction of the theory of pricing and hedging derivatives in a complete model,

  including American type derivatives, we move to forward and futures contracts, and then to term

  structure models, including the models of Vasicek, Cox-Ingersoll-Ross. The Heath-Jarrow-Morton

  framework is also given some coverage. If time permits, we extend the theory of options to

  include stochastic interest rates, where we present the Amin-Jarrow (1992) solution for the pricing

  of a European call option by the use of the forward measure.

  • We then analyze optimal consumption and portfolio choice in a dynamic setting for the time and

  state continuous models. As an example we show explicitly how to solve the celebrated Merton¿s

  problem, when the consumer has constant relative risk aversion.

  • The last part consists of dynamic equilibrium theory in a continuous time setting. Here we

  present the Arrow-Debreu equilibrium, and the Lucas consumption based equilibrium model. It is

  shown, in particular, how one may implement the Lucas-type equilibrium in an Arrow-Debreu

  setting for a complete market, based on an idea of Roy Radner. As an illustration, we show how

  the Black/Scholes formula may alternatively be derived in an equilibrium of this type.

   

  Furthermore, we derive the Cox-Ingersoll-Ross term structure model as an equilibrium solution, as

  it was originally published. We round off with the consumption based capital asset pricing model

  (CCAPM). If time permits, we may also study incomplete models at an introductory level, and

  perhaps also extend the model of the underlying uncertainty to Lévy-based processes containing

  unpredictable jumps at random time points.

  The course requires knowledge in modern microeconomics, some micro based macroeconomics,

  intermediate and graduate finance, and modern probability theory. For the latter, it is an advantage

  to have taken, or take in parallel, the course "An introduction to stochastic analysis with

  applications", also given in the spring semester.

   

  Topics

  1. The Black/Scholes model

  2. State prices and equivalent martingale measures

  3. Term structure models

  4. Derivative pricing

  5. Portfolio and consumption choice

  6. Equilibrium in continuous time models

• Learning outcome

  The contents of this course is considered to be more or less an ¿industry standard¿ in financial

  pricing theory, although it was rather ¿far-fetched¿ only a few years back. It is now a prerequisite

  in order to understand much of the extant literature, both the theoretical as well as a large part of

  the empirical research in the field of financial economics.

  The objective is to understand the theories of pricing in financial markets, to formulate the

  consumers¿ problem, and to understand the concept of equilibrium in a world of uncertainty. As a

  prerequisite a course in stochastic calculus is highly recommended. The student should be able to

  start own work in finance using the tools in this course, but can not expect to become an expert in

  this material after just a one semester course. 

• Teaching

   This course will be taught on a regular basis, meeting two times a week, each time 2 x 45 minutes,

  throughout the whole semester. As we go along, problem sets will be expected solved by the

  students from each main section.

  This course contains material that typically needs maturing, and thus the course is not well suited

  for an intensive presentation during a relatively short period. The work with the problems is very

  important in order to obtain the necessary skills and understanding of the material. We expect to

  present a relatively rich set of illustrations of each chapter through the exercises.

  Since the aim of this course is to prepare the student to publish in international journals, all coursework (problem sets, and exam) must be completed in English

• Requirements for course approval

  Satisfactory solutions of a number of exercise sets during the course.

• Assessment

   3 hours written school exam. The final exam is closed book

• Grading Scale

  A-F