Latest update: November 14, 2024.
Office: D521 (Building 2)
Office hours: by appointment
This course aims to provide a comprehensive introduction to the pricing of financial assets. We will cover the main pillars of asset pricing, including choice theory, binomial pricing, portfolio theory, equilibrium pricing, and arbitrage pricing.
Some empirical evidence will also be discussed and there will be exercises with real data. We will use Excel for the empirical problems, thus it is recommended for students to be at least basic users of Excel. Techniques that are used for the course will be introduced in the classes.
At the end of the course, you will be able to read a significant range of current research papers in asset pricing and understand the main issues being discussed.
The course description is also available in a pdf file.
The final grade is computed as follows:
Final exam: 40%
Quizzes: 40%
Group work: 20%
The exams are closed-book and closed-notes. However, you may use a formula sheet, a two-sided A4 sheet on which you can write whatever you want to.
Group works will be empirical assignments the groups must carry out, and then present in class.
The assignments are the following:
Assignment 1: pdf
Assignment 2: pdf
Assignment 3: pdf. For this assignment I recommend you to read the case "Understanding Risk and Return, the CAPM, and the Fama-French Three-Factor Model", Tuck School of Business at Dartmouth, No. 03-111 (actually it is a recommendable reading not only for the assignment, but also for the exam): pdf
In case you have any doubt/question/comment regarding the assignments please let me know, since my help is allowed.
Introduction (slides)
Main topics:
The objectives of asset pricing
Different approaches to value risky cash flows
Readings:
DD (Chapter 2)
Choice Theory, Utility Functions, and Risk Aversion (slides)
Main topics:
Introduction to choice theory
Definition and measures of risk aversion
Important utility functions: quadratic, exponential, log, and power
Readings:
DD (Chapters 3 and 4)
Back (Chapters 1 and 20)
Problem set:
Problem set 1 (pdf)
Bond Pricing in the Multi-Period Binomial Model (slides)
Main topics:
The binomial model
Binomial model for the short rate
Pricing bonds and their derivatives with the binomial model
Readings:
Haugh and Iyengar's slides
Problem set:
Problem set 2 (pdf)
Additional material:
Portfolio Theory (slides)
Main topics:
Definition and solution of the canonical portfolio problem
Simplification of the portfolio problem through mean-variance preferences
Computing the frontier with n risky assets
Computing the frontier with n risky and one riskless asset
Readings:
DD (Chapters 5 and 6)
Back (Chapters 2 and 5)
Problem set:
Problem set 3 (pdf)
Additional material:
Capital Asset Pricing Model (slides)
Main topics:
Capital market line
Security market line
Economic intuition for why stocks with higher covariance with the market (beta) have higher returns
Readings:
DD (Chapter 7)
Back (Chapter 6)
Arbitrage Pricing Theory and Factor Models (slides)
Main topics:
Factor structure of stock returns
The market model
Arbitrage arguments and the pricing equations
Fama and French's 3-factor model
Application to fund performance
Readings:
DD (Chapter 13)
Back (Chapter 6)
Womack et al, 2003, Understanding Risk and Return, the CAPM, and the Fama-French Three-Factor Model, Tuck School of Business at Dartmouth, Case 03-111. (pdf)
Pricing in Complete Markets (slides)
Main topics:
The concept of complete markets
Arrow-Debreu pricing
Risk-neutral pricing
Readings:
DD (Chapters 10 and 11)
Back (Chapters 3 and 4)
Problem set:
Problem set 4 (pdf)
Danthine, J-P. and J. Donaldson, 2005, Intermediate Financial Theory, 2nd edition, Elsevier Academic Press. [DD]
Back, 2010, Asset Pricing and Portfolio Choice Theory, Oxford University Press. [Back]
Slides for the MOOC: Financial Engineering and Risk Management, by Martin Haugh and Garud Iyengar. Part 1, Part 2
Financial Economics:
Ingersoll, J.E., 1987, Theory of Financial Decision Making, Rowman & Littlefield. [Ingersoll]
Huang, C-F. and R. H. Litzenberger, 1988, Foundations for Financial Economics, Prentice Hall. [HL]
Pennacchi, G., 2008, Theory of Asset Pricing, Pearson. [Pennacchi]
Undergraduate Finance:
Bodie, Kane, and Marcus, 2005, Investments, McGraw-Hill. [BKM]
Microeconomics:
Varian, H.R., 1992, Microeconomic Analysis, W.W. Norton & Company. [Varian]
Mas-Colell, A., M.D. Whiston, and J.R. Green, 1995, Microeconomic Theory, Oxford University Press. [MCWG]
Mathematics and Econometrics:
Chiang, A.C., 1984, Fundamental Methods of Mathematical Economics, McGraw-Hill. [Chiang]
Greene, W.H., 2003, Econometric Analysis, Prentice Hall. [Greene]