ECO421 Asset Pricing

• Topics

  Topics

  The course introduces students to the economic principles behind models of rational valuation and investment choice. To keep the mathematics at a minimal level, results are generally formulated in a discrete-time setting, with an emphasis on the one-period setting. The course sets out by clarifying the foundation of financial economics; the relationship between equilibrium or the absence of arbitrage opportunities and the existence of a system of state prices. All asset prices are then shown to be bundles/portfolios of state prices; stocks, bonds, derivatives etc. The course also demonstrates that classic models like the Capital Asset Pricing Model (CAPM) and the Black- Scholes-Merton option pricing formula are special instances of the same basic economic framework. Topics include, but are not limited to

   

  1. Introduction

  Asset Pricing: Equilibrium vs Arbitrage Risk Aversion, Fair Gambles

  Investor Preferences and Risky Investments Absolute and Relative Risk Aversion

   

  Readings: CWS 3 (HL 1, 2)

   

  2. Investment Decisions in a State Contingent Claim Framework

  The Framework

  Optimal Investment Decisions Elementary Linear Algebra

  Spanning: Complete versus Incomplete Markets Pricing of Securities and No-Arbitrage Conditions

   

  Readings: CWS 4 (HL 5)

   

  3. Investment Decisions Based on Arbitrage/Replication Arguments

  The Binomial Option Pricing Framework

  American Options, Path Dependence, Exotic Options

   

  Readings: CWS 7 (HL 8)

   

  4. The Term Structure of Interest Rates

  Spanning & pricing using treasuries

  Discount factors, spot rates, and forward rates

  Term Structure Theories

   

  Readings: CWS 8

   

  5. Portfolio choice, the CAPM, and APT

  Markowitz' portfolio choice model

  The CAPM with homogeneous beliefs

  - with riskless asset

  - without riskless asset

  The CAPM with heterogeneous beliefs

  Ross' multi-factor asset pricing model (the APT)

   

  6. Additional topics

  Stochastic Discount Factors & Asset Pricing

  The Equity Premium Puzzle; multi-period consumption-based asset pricing models

  Topics in Continuous Time Finance

   

  This syllabus is tentative. Changes in this document and to the plans for this course are likely (for instance to accommodate student interests, new developments, or current events).

• Learning outcome

  Learning outcome

  After completing the course, the students will:

  • know the fundamental theory of financial economics
  • understand the economic reasoning underlying financial economics
  • be able to discern the important assumptions, features and empirical predictions of theoretical models in financial economics
  • know the origin of finance models and understand the relationship between these models
  • be able to formulate and conduct quantitative analyses
  • understand the distinction between equilibrium and arbitrage asset pricing, the key elements of each approach, and their relative strengths and weaknesses
  • understand the relationship between spanning and pricing in arbitrage models
  • understand the relationship between portfolio choice, partial/general equilibrium, and asset prices in equilibrium models
  • be able to use the tools from asset pricing to related tasks such as hedging, return

  & risk modeling

  • be able to discuss current events in financial markets from an asset pricing standpoint.

• Teaching

  Teaching

  Regular lectures

• Required prerequisites

  Required prerequisites

  From Fall 2015 the following prerequisites will apply:

  To take this course you should already have skills in

  • decisions under uncertainty similar to those obtained in ECO400,
  • optimizations similar to those obtained in ECO401,
  • and skills in basic asset pricing similar to those obtained in FIE400.

• Requirements for course approval

  Requirements for course approval

  To complete this course, the student must obtain course approval (kursgodkjenning), based on homework and other assigned course activities, and pass a 4-hour final exam. Students who have not obtained course approval prior to the final exam will not be allowed to take the exam. To obtain course approval, the student must complete individually all course assignments, hand them in, and receive a passing average grade. The average grade to pass will vary as the assignments and their difficulty may vary from semester to semester. All coursework, including all exams and assignments, must be completed in English.

• Assessment

  Assessment

  Four hour written school exam.

  The exam will be given in English and has to be answered in English.

• Grading Scale

  Grading Scale

  Grading scale A-F

• Computer tools

  Computer tools

  Spreadsheet (Excel)

• Semester

  Semester

  Spring

   

• Literature

  Literature

  Primary Textbook: Copeland, T. S., Weston, F., & Shastri, K. (2005) ( CWS ), "Financial Theory and Corporate Policy," Fourth Edition, Addison Wesley, ISBN 0-321-22353-5.

   

   

   

  Advanced texts (PhD level):

  Huang, Chi-fu & Litzenberger, Robert H., (1988) ( HL ), "Foundations for Financial Economics", North-Holland.

  Dothan, D. (1990), "Prices in Financial Markets" Cochrane, J. H. (2005), "Asset Pricing," Revised Edition

   

   

  Additional Readings may be assigned.