EC824. Financial Economics and Asset Pricing 2013/14

Transcription

1 EC824 Financial Economics and Asset Pricing 2013/14

2 SCHOOL OF ECONOMICS EC824 Financial Economics and Asset Pricing Staff Module convenor Office Keynes B1.02 Dr Katsuyuki Shibayama Teaching information Teaching period Teaching pattern Hours of study Spring One 2 hour lecture/seminar per week Contact hours 24 Private study hours 126 Total study hours 150 Assessment Task Weighting Test/exam date Coursework submission date Class Test 10% Mon in wk 21 N/A Class Test 10% Mon in wk 23 N/A Exam 80% Summer term 2014 N/A Coursework submission policy All coursework must be submitted by the deadline stipulated by the module convenor, as listed above, to the School of Economics General Office, Mg.14 Keynes College. All coursework should be accompanied by a completed cover sheet. No extensions to submission deadlines are granted. If you miss the deadline and submit the coursework late, you must also submit a concessions form for late submission, available from the Social Sciences Faculty Office,

3 SCHOOL OF ECONOMICS EC824: Financial Economics and Asset Pricing Spring 2013/2014 Introduction The module will develop students skills in asset pricing and understanding of their theoretical basis. The module stresses the practical side of the methods. In this module, we study the arbitrage asset pricing theory in continuous time. The main idea here is the equivalent martingale measure (EMM), which is not a real-world probability. Instead of working on the real-world probability, we construct a probability distribution under which investors behave as if they are risk-neutral. Under EMM, since no risk premium appears, all calculations reduce to the calculations of discounted expected value. This asset pricing framework is quite general, including the standard Black-Scholes- Merton option pricing formula. In addition, we also study some useful stochastic processes and some simple applications to real options. We also discuss a bit of ideas of computation. The module is mathematically challenging for most students. However, rather than chasing the mathematical foundation, the module puts stress on the intuitions and heuristics behind theorems and formulae. The ultimate aim of the module is so that students can solve actual problems. In this regard, understanding theorems and formulae is not enough for this module; rather what students are required is using theorems and formulae. Aims of the Module The module aims: to develop students skills in probability theory and stochastic calculus to offer the introductory training of the martingale asset pricing, including Black- Scholes-Merton option formula and its variants to offer the training to solve other models of stochastic processes to offer the training to solve the environmental and resource problems as applications of the derivative pricing theory to develop students skills to extract model parameters from the data and to develop students understanding of basic computation strategies Learning Outcomes of the Module By the end of the module, students will: understand the mathematical principles of the derivative pricing understand the main ideas of computation for more complicated derivative pricing be able to derived the analytical solution to the basic derivative prices be able to use some stochastic processes to model some asset prices be able to find hidden options (real options) in daily life and real business activities 1

4 Organisation of Teaching The module is taught by means of nine two-hour lectures and three two-hour exercise sessions. Students are required to solve exercises in advance, and the solutions are discussed in the exercise sessions. Solving exercises are essential because they are good training to master the key skills. In the first sub-module, a brief introductory session on statistics and Ito calculus is offered. This session treats mathematics heuristically so that students can use it to obtain some analytical results. Also, mathematical and general help is provided in exercise sessions and office hours. The module s material is technical in nature, but the module emphasises the intuition behind the analyses. During the term time, one computer session is offered; in which students are required to extract model parameters from the data and understand how to compute the prices of more complicated financial derivatives. The module is compulsory for MSc in Economics and Finance, and is optional for other MSc programmes. Students who take this module should be familiar with practices in financial markets, basic statistics and intertemporal optimisation; it is recommended to take EC805 (Advanced Macroeconomics) and EC822 (Financial Economics I) in the autumn term. Students preferably should also have a reasonable mathematical background, although short mathematics sessions are provided at the beginning. Feel free to obtain advice about your registration from the module instructor. Module Arrangements Time and Location: Monday 16:00-18:00 in KS11, Keynes Office Hours: Monday 14:30-15:30 & Thursday 14:30-15:30, Keynes B1.02 (No appointment is required for office hours) Instructor: Katsuyuki Shibayama k.shibayama@kent.ac.uk Phone: (82)4714 Assessment The final mark for this module is based on the two-hour exam (80%) in the summer term and two mini tests (20%) during the term. Though they carry significant weights in the final grade, the aim of the mini tests is to detect the weak points at early stages. The final exam follows the same format as the seminar exercises. The past exam papers are available at Moodle, but be careful that the coverage of the exams in and before 2012 are different. Mini Test 1 (week 21) Worth 10%. This test is on the issues discussed in weeks 13 to 20. Mini Test 2 (week 23) Worth 10%. This test is on the issues discussed in weeks 13 to 22. Final exam (summer term) Worth 80%. The exact date is to be announced (in the summer term). 2

5 EC824 Financial Economics II - Reading List Main textbooks Given complex nature of the area, I rather recommend focussing only on my lecture notes, in which (i) notations are consistent throughout and (ii) math is properly abused. I personally think Bjork (2004) is the most precise and comprehensive, but I do not really recommend this (a bit too tough). If you really want to see other sources, perhaps, Baxter and Rennie (1996) for heuristic math and Dixit and Pindyck (1994) for real options are quite readable and manageable. For martingale asset pricing (arbitrage asset pricing), Martin Baxter and Andrew Rennie (1996) Financial Calculus An introduction to derivative pricing, Cambridge University Press. This is good for intuition Tomas Bjork (2004) Arbitrage Theory in Continuous Time, Oxford University Press. This is just good. Stanley R. Pliska (1997) Introduction to Mathematical Finance Discrete time Models, Blackwell Publishers Inc. This focuses on discrete time models For practical aspects of derivatives and market conventions, Frank K. Reilly and Keith C. Brown (2005) Investment Analysis and Portfolio Management, 7th ed., Dryden Press. This is for business professionals (non-technical). John C. Hull (2006) Options, Futures, and Other Derivatives, Prentice Hall. This is the best bridge between academics and business. For real options, Avinash K. Dixit and Robert S. Pindyck (1994) Investment Under Uncertainty, Princeton University Press. This is the textbook in the area. Conrad (1997) On the Option Value of Old-Growing Forest, Ecological Economics. This is the simplest application of the model to the data. Also, the following textbooks are good for financial economics. John Y. Campbell and Luis M. Viceira (2002) Strategic Asset Allocation Portfolio Choice for Long-Term Investors, Oxford University Press. John Y. Campbell, Andrew W. Lo and A. Craig MacKinlay (1997) The Econometrics of Financial Markets, Princeton University Press John H. Cochrane (2001) Asset Pricing, Princeton University Press 3

6 EC824 Financial Economics II - Module Outline Week 1-4: Math Prep Very Basics --- any textbook is fine. Discount Factor in continuous time, etc. Basic Statistics --- any textbook is fine. Change of Variables Completion of Square, etc. Ito Calculus --- Hull (2006) Ch12, BR (1996) Ch3 Wiener Process, Geometric Brownian Motion (GBM), etc. Ito s Lemma Ito Integral: Isometry, Stochastic Exponential, etc. Week 5-8: Martingale Asset Pricing Risk Neutral Pricing --- BR (1996), Bjork (2004) Girsanov Theorem and Radon-Nikodym Derivative Equivalent Martingale Measure (EMM) and Market Price of Risk Option pricing under EMM (BSM formula) and its variants Intuition Understand why we can use martingale measure to study the actual markets where risk-averse investors evaluate asset prices in reality. Stochastic Processes (Other than GBM) Vasicek Model (Ornstein-Uhlenbeck Process) for short-term interest rate Brownian Bridge for forward contracts Toward Computation Parameter Extraction from the data Some Computation Ideas Week 9-12: Real Options Math Prep --- Dixit and Pindyck (2006) Ch1-4 Value function, Bellman equation, etc. Partial (and Ordinary) Differential Equations Free boundary conditions (Value Matching and Smooth Pasting conditions) Applications --- Dixit and Pindyck (2006) Ch1-4 Intuition: Irreversible decision under uncertainty Value of investment opportunity Optimal Stopping Time for investment timing, etc. 4