The objective of this course is to undertake a rigorous study of the foundations of modern financial economics in discrete-time settings. The course will cover the central themes of modern finance including decisions under uncertainty, mean-variance theory, dynamic capital-market equilibrium and asset valuation, and the potential application of these themes. So-called consumption-based models provide testable implications for the joint distribution of asset prices and macroeconomic quantities. These models and their empirical challenges will be addressed and discussed. Upon completion of this course, students should acquire a clear understanding of the major theoretical results concerning individuals' decisions under uncertainty, market clearing, and their joint implications for the valuations of securities.
- Introduction and overview, review of basic economic theory, some empirical facts
- Preferences, risk aversion
- Portfolio choice in a two-period model
- Markets: complete vs. incomplete, equilibrium, risk sharing
- Arbitrage, state prices, law of one price, stochastic discount factors
- Mean-variance analysis, beta representations
- Conditional vs. unconditional models
- Dynamic consumption-portfolio choice, dynamic programming
- Equilibrium models, consumption CAPM, special cases
- Exotic preferences: recursive, habit formation
- Production models
- Market imperfections: asymmetric information, transaction costs, capital immobility
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