JCU Logo

JOHN CABOT UNIVERSITY

COURSE CODE: "EC 490"
COURSE NAME: "Advanced Financial Economics"
SEMESTER & YEAR: Fall 2017
SYLLABUS

INSTRUCTOR: Francesco Ruscitti
EMAIL: [email protected]
HOURS: MW 4:30-5:45 PM
TOTAL NO. OF CONTACT HOURS: 45
CREDITS: 3
PREREQUISITES: Prerequisites: EC 301, FIN 301, MA 299; Recommended: MA 491
OFFICE HOURS: after class and by appointment. To set an appointment, approach me in class or send me an email ahead of time

COURSE DESCRIPTION:
This is an advanced course that makes substantial use of mathematical methods. In general, the topics covered can be viewed as that subset of general equilibrium theory which focuses on complete and incomplete financial markets and their impact on the allocation of consumption goods and efficiency. The course focuses on the operation of financial markets and pricing of financial assets. In the first part of the course, basic techniques and principles of decision making under uncertainty will be developed. These principles will then be applied to portfolio selection problems in financial asset markets. Microeconomic models of financial asset markets and their implications for valuation of stocks, bonds and derivative assets will be examined. The analysis will explore the impact of risk and ambiguity on asset prices and allocations in asset markets. For the most part, it will be assumed that there are two dates and a single consumption good. This basic setting is suitable for the study of the relation between risk and return on securities, and the role played by securities in allocation of risk.
SUMMARY OF COURSE CONTENT:

Note: This is a preliminary draft of the syllabus. At the beginning of the semester, I will hand out and post the definitive version which will be much more detailed than this and will spell out all of my policies (including the assessment method)



Note: Knowledge of the following topics is indispensable and will be assumed: intermediate microeconomics, basic finance, calculus I and calculus IINOTE: I will be using also basic linear algebra throughout the course (e.g., matrix algebra, basic properties of vector spaces, inner product, vector subspaces and linear span of a subset of vectors, the concept of linear independence etc.). The linear algebra-related tools that are needed will be explained as carefully as possible. However, some basic knowledge of linear algebra is very helpful.

Financial economics lies at the intersection of Finance and Economics. This is an advanced undergraduate course that employs mathematical methods and tools. Nowadays, Financial Economics plays an increasingly important role in the training of economists. This is largely due to the transformation in capital markets that has occurred in recent years, and to the rapid development of the field itself. In fact, Financial economics is gradually taking center stage in the economic analysis of issues that involve time and uncertainty. 



A sample of topics to be covered is as follows: Equilibrium in security markets (competitive equilibrium under uncertainty, sequential trading and rational expectations); arbitrage, state prices and valuation; the fundamental theorem of finance; valuation under portfolio restrictions; preferences under risk and ambiguity; risk and risk aversion; optimal portfolios; equilibrium prices in security markets (consumption-based security pricing); Pareto-optimal allocation of risk; effectively complete security markets; mean-variance analysis; CAPM.

LEARNING OUTCOMES:
The main course objectives are that students understand the operation of financial markets, basic principles of decision making under uncertainty, portfolio selection problems in financial asset markets, and the development of models of financial asset markets and their implications for valuation of stocks, bonds and derivative assets. The analysis of finance will be based on modern microeconomic theory. It aims at constructing (relatively) simple mathematical models to study the welfare properties of financial markets, and the implications for asset prices.



First of all, the objective of this course is that students develop analytical skills and learn to work with formal economic models. Students will develop the ability to model financial markets using mathematics. Students will get acquainted with an overview of the theory of financial markets from an economic perspective. The major conceptual tool students will learn is the notion of economic equilibrium.

·       Understanding the role of financial markets in hedging and insuring participants against risk.

·       Understanding the efficiency properties of financial markets, and the perverse equilibrium effects that less-than-perfect financial markets can have, with consequences for asset pricing.

Referring to the learning outcomes (LOS) for the Economics and Finance major (that are posted online), by taking this course students will:



LOS 1: Build a solid understanding of and knowledge base in microeconomics and financial economics.



LOS 2: Develop critical-thinking skills and learn to apply microeconomic analysis to understand economic events and everyday problems.



LOS 5: Develop adequate training in mathematical methods to develop problem-solving skills, perform proofs, carry out formal analysis, and prepare for further graduate studies in the areas of economics and finance.



LOS 6: Master solid communication skills that enable them to formulate a well-organized argument and communicate effectively in written and graphical form about specific financial issues.

TEXTBOOK:
Book TitleAuthorPublisherISBN numberLibrary Call NumberComments
Principles of Financial Economics, second edition, 2014S. F. LeRoy and J. WernerCambridge University PressISBN 978-1-107-02412-0  
REQUIRED RESERVED READING:
NONE

RECOMMENDED RESERVED READING:
NONE
GRADING POLICY
-ASSESSMENT METHODS:
AssignmentGuidelinesWeight
Midterm exam 1 Numerical problems and open-ended questions in which students are asked to prove specific claims and results formally. More details will be provided in class.25%
Midterm exam 2 (or a short research paper-more details will be provided later)Numerical problems and open-ended questions in which students are asked to prove specific claims and results formally. More details will be provided in class.30%
Final exam (cumulative)Numerical problems and open-ended questions in which students are asked to prove specific claims and results formally. More details will be provided in class. The final exam will cover all the material taught throughout the course.45%

-ASSESSMENT CRITERIA:
AWork of this quality directly addresses the question or problem raised and provides a coherent argument displaying an extensive knowledge of relevant information or content. This type of work demonstrates the ability to critically evaluate concepts and theory and has an element of novelty and originality. There is clear evidence of a significant amount of reading beyond that required for the course. 93-100:A. 90-92.99:A-
BThis is highly competent level of performance and directly addresses the question or problem raised.There is a demonstration of some ability to critically evaluatetheory and concepts and relate them to practice. Discussions reflect the student’s own arguments and are not simply a repetition of standard lecture andreference material. The work does not suffer from any major errors or omissions and provides evidence of reading beyond the required assignments. 86-89.99:B+. 83-85.99:B. 80-82.99:B-
CThis is an acceptable level of performance and provides answers that are clear but limited, reflecting the information offered in the lectures and reference readings. 75-79.99:C+. 70-74.99:C. 65-69.99:C-
DThis level of performances demonstrates that the student lacks a coherent grasp of the material.Important information is omitted and irrelevant points included.In effect, the student has barely done enough to persuade the instructor that s/he should not fail. 60-64.99:D+. 55-59.99:D. 50-54.99:D-
FThis work fails to show any knowledge or understanding of the issues raised in the question. Most of the material in the answer is irrelevant. Below 50:F

-ATTENDANCE REQUIREMENTS:

Given the nature of the subject matter (fascinating but fairly challenging and technical), the aim and scope of the course, and since the lectures will hinge upon fairly advanced material, students are required to attend: ATTENDANCE IS MANDATORY. If you are not committed to attending all lectures and working hard, you should not enroll in this class. If you really have to miss a class, please let me know beforehand. If you have a very good reason for skipping a class, I will not penalize you. Just speak with me. I will be as flexible as possible in accommodating your request and meeting your needs.

EXAMS AND POLICY ON ABSENCES: At the beginning of the semester I will circulate the final draft of the syllabus with the exact exam dates. In general, there are NO make-up for missed midterm exams (the exam dates will be scheduled well ahead of time). If, for any compelling reason, you happen to miss a midterm exam, I want you to notify me ahead of time (if possible) and I will ask you to provide me with a formal justification for the absence. You have to prove your claim about the cause of your absence. If I deem the justification is formal, legitimate and merits consideration, then I would let you take a make-up exam. Note: regarding the final exam, there are specific policies put in place by JCU, and I shall comply with them.

ACADEMIC HONESTY
As stated in the university catalog, any student who commits an act of academic dishonesty will receive a failing grade on the work in which the dishonesty occurred. In addition, acts of academic dishonesty, irrespective of the weight of the assignment, may result in the student receiving a failing grade in the course. Instances of academic dishonesty will be reported to the Dean of Academic Affairs. A student who is reported twice for academic dishonesty is subject to summary dismissal from the University. In such a case, the Academic Council will then make a recommendation to the President, who will make the final decision.
STUDENTS WITH LEARNING OR OTHER DISABILITIES
John Cabot University does not discriminate on the basis of disability or handicap. Students with approved accommodations must inform their professors at the beginning of the term. Please see the website for the complete policy.

SCHEDULE

TOPICS AND TENTATIVE SCHEDULE

 

(Please note that the schedule of the topics covered might be subject to change. More details will be provided in class. There might not be enough time to go over all of the topics indicated below)


 

 

 

 

Weeks

Topics

Reading Assignment

Exam dates and topics covered (TBA)

 

EQUILIBRIUM IN SECURITY MARKETS AND LINEAR PRICING

 

 

1, 2

Security markets, consumption and portfolio choice, general equilibrium, existence and uniqueness of equilibrium, the law of one price, the payoff pricing functional, linear equilibrium pricing, state prices in complete markets.

Chapters 1 and 2 of LeRoy and Werner (2014).

 

 

ARBITRAGE, STATE PRICES AND VALUATION

 

 

3, 4

Theorems on arbitrage and optimal portfolios, positivity of the payoff pricing functional, state prices and the absence of arbitrage, risk-neutral probabilities, the payoff pricing functional, valuation of contingent claims (the valuation functional), the fundamental theorem of finance.

Chapters 3, 5, and 6 of LeRoy and Werner (2014).

 

 

 

TECHNICAL TOOLS: THE FARKAS-STIEMKE LEMMA

 

 

5

Farkas’ lemma and Stiemke’s lemma

Chapter 6 of LeRoy and Werner (2014).

 

 

VALUATION UNDER PORTFOLIO RESTRICTIONS

 

 

6

Short sales restrictions, the law of one price, arbitrage under short sales restrictions, asset span and pricing functional under short sales restrictions, state prices under short sales restrictions (various theorems)

Chapters 4 and 7 of LeRoy and Werner (2014).

.

 

PREFERENCES UNDER RISK AND AMBIGUITY

 

 

7, 8

Expected utility, state-dependent expected utility, Ellsberg paradox, multiple-prior expected utility, variational preferences.

Chapter 8 of LeRoy and Werner (2014).

 

 

RISK

 

 

9, 10

Risk and risk aversion, greater risk and variance, a characterization of greater risk (various theorems).

Chapters 9 and 10 of LeRoy and Werner (2014).

 

 

OPTIMAL PORTFOLIOS

 

 

11

Optimal portfolios with one risky security, optimal portfolios with many risky securities, optimal portfolios under fair pricing, risk-return trade-off.

Chapters 11 and 13 of LeRoy and Werner (2014).

 

 

EQUILIBRIUM PRICES IN SECURITY MARKETS AND PARETO-OPTIMAL ALLOCATION OF RISK

 

 

12, 13

Consumption-based security pricing, equilibrium consumption and expected returns, volatility of marginal rates of substitution, first welfare theorem in complete security markets. Pareto-optimal allocations under various types of preferences and attitudes toward risk, effectively complete security markets (various theorems).

Chapters 15 and 16 of LeRoy and Werner (2014).

 

 

MEAN-VARIANCE ANALYSIS AND THE CAPITAL ASSET PRICING MODEL

 

 

14

Some results from mathematics (Hilbert spaces), the expectations and pricing kernels, mean-variance frontier payoffs, frontier returns, mean-variance efficient returns, the CAPM: mean-variance preferences, the security market line.

Chapters 17, 18 and 19 of LeRoy and Werner (2014).

 

 

 

 

Final exam (cumulative)