Financial Economics
Financial Economics
Professor: Vincent Chang, vhchang@phbs.pku.edu.cn , C206
This course provides a basis in the neoclassical theory of finance that underlies other finance courses. This course is primarily concerned with static, i.e. one period, theories of finance. This course will convey more conceptual understanding of finance than exercise complicated mathematical derivations. It starts with examining the data and then develops basic finance theory to explain the data. Following this course, students should be prepared for advanced courses in finance, such as dynamic theories, continuous time finance, empirical finance, and advanced corporate finance.
The course will be lectured in English. You are required to attend all the lectures and present your name card during the lectures at all time. Please note that class participation will be counted toward your final course grade.
In addition, there will be a one hour of discussion section each week held by the TA. Attending the discussion is not required but strongly encouraged.
Although there are no required textbooks, the following textbooks are recommended:
1. Stephen F. Leroy & Jan Werner, Principles of Financial Economics, Cambridge University Press, 2001
2. John H. Cochrane, Asset Pricing, Princeton University Press, 2001
3. Jonathan E. Ingersoll, Theory of Financial Decision Making, Rowman & Littlefield, 2000
4. Jiang Wang, Financial Economics (in Chinese), Renmin Publishing, 2005
Problem sets will be given throughout the lectures. The class grade will be based on a midterm exam (30%), a final exam (50%), class participation (10%), and problem sets (10%).
Course Outline
1. Finance and Data
a. Stylized Facts
2. Static Portfolio-Consumption Problem
a. Two States of Nature and Complete Markets
b. Arbitrary State Space: One Riskless Asset and One Ricky Asset
c. Finite State Space Model and General Portfolio Problem
d. Arrow-Debreu Markets
e. Complete Market and Options
3. Fundamental Theory of Finance
a. Absence of Arbitrage and Efficient Markets
b. Existence of Positive Linear Pricing Rule
c. Risk Neutral (Martingale) Probabilities and State Pricing
4. Arbitrage Pricing Theory
a. Basic Structure
b. Infinite Dimensional and Hilbert Space Approaches
5. Options, Derivatives and Other Financial Instruments
a. Options
b. Futures and Forwards
c. Valuing Options—Binomial Case
6. Introduction to Corporate Finance
a. Modigliani-Miller (MM) Theorem
7. Preferences and Uncertainty
a. Expected Utility Theory
b. Linear Risk Tolerance Preferences
c. Jensen’s Inequality and Risk Aversion
d. Ordering Preferences by Risk Aversion
e. Stochastic Dominance
f. Insurance and Certainty Equivalence
g. Alternative Psychological and Behavioral Approaches
8. Mean Variance Theory, Spanning and Separation Theorems
a. Distribution vs. Preference Based Approaches to Mean Variance Optimization
b. Skewness and Alternative Approaches
9. Capital Asset Pricing Model (CAPM)
a. Sharpe-Litner-Mossin Theory
b. Riskless Assets and Zero Beta Theory: Linear Pricing and Arbitrage
c. Roll’s Critique and Empirical Testing
d. Short Sales Restrictions and Borrowing Constraints
e. Systematic Risk, Performance Evaluation and Other Approaches
10. Asymmetric Information Models
a. Aggregation with Differential Prior Beliefs
b. Rational Expectations Equilibria: Conditioning on Prices
c. Agency and Signaling Models
d. Market Microstructure
Course Schedule (Tentative):
Lecture #01 Finance & Data
Lecture #02 Portfolio-Consumption Problem
Lecture #03 Portfolio-Consumption Problem (cont.)
Lecture #04 Fundamental Theory of Finance
Lecture #05 Fundamental Theory of Finance (cont.)
Lecture #06 Arbitrage Pricing Theorem
Lecture #07 Arbitrage Pricing Theorem (cont.)
Lecture #08 Options & Derivatives
Lecture #09 Corporate Finance
Lecture #10 Corporate Finance (cont.) / Preference Theory
Lecture #11 Midterm Exam, covering Lectures #01-#09
Lecture #12 Preference Theory (cont.)
Lecture #13 Portfolio Theory
Lecture #14 Portfolio Theory (cont.)
Lecture #15 Consumption Beta Theory
Lecture #16 Consumption Beta Theory (cont.)
Lecture #17 Capital Asset Pricing Model (CAPM)
Lecture #18 CAPM (cont.) / Market Microstructure