FALL 2006 Prof Jos Scheinkman Prof Markus K Brunnermeier email joses princeton edu http www princeton edu joses Office 210 Dial Lodge Office Hours TBA ECO525 FIN595 Financial email markus princeton edu http www princeton edu markus Office 205 Dial Lodge Office Hours Wed 4 45 6 15 pm Economics I Time and Location MW 1 10 pm 2 30 pm Room 103 Bendheim Center for Finance Dial Lodge Aim of the Course This course is the first of a sequence of two courses in Financial Economics The aim of Financial Economics I is to provide an introduction to asset pricing and portfolio theory This term s course is divided into two parts The first half of this course taught by Professor Brunnermeier introduces students to asset pricing in discrete time covers models in which market participants can have different information and studies bubbles and liquidity crises The second part taught by Professor Scheinkman emphasizes the consequences of the absence of arbitrage and continuous time equilibrium models Professor Shin will teach Financial Economics II which focuses on corporate finance next spring Structure of the Course Part I Asset Pricing in Discrete Time 1 Basics of Asset Pricing under Symmetric Information with Homogenous Beliefs a One period Models DD1 LW3 Security structure and Market LOOP No Arbitrage The three Pricing Formulas Arrow Debreu State Prices Stochastic Discount Factor Martingale Pricing Optimality Representative Agent Analysis b State price Beta Model c Mean Variance Analysis Beta Pricing CAPM LW17 19 d Factor Pricing Models APT FF LW20 optional e Multi period Models LW21 28 Conditional versus Unconditional Betas Dynamic Market Completeness Risk Neutral Valuation Hedging Demand 2 Asset Pricing under Asymmetric Information a Allocative and Informational Efficiency B1 b Existence of EMM c Market Microstructure Models B3 Rational Expectations Equilibrium versus Bayesian Nash Equilibrium Concept Insider Trading Models and Sequential Trade Models d Higher Order Uncertainty No Trade Theorems B1 optional 3 Introducing Heterogeneous Beliefs a Representative Agent Analysis b Existence of EMM 4 Bubbles and Limits to Arbitrage a Noise trader risk b Synchronization Risk 5 Liquidity and Risk Management optional a LTCM case and Predatory Trading b Funding Liquidity versus Market Liquidity Part II Asset Pricing in Continuous Time and Stochastic Calculus The structure of the second part of the course will be announced later in the semester Given the time constraints we cannot guarantee that all topic will be covered Textbooks The main textbooks are DD Dynamic Asset Pricing Theory Darrell Duffie Princeton University Press 2001 third edition LW Principles of Financial Economics Stephen F LeRoy and Jan Werner Cambridge University Press 2001 B Asset Pricing under Asymmetric Information Bubbles Technical Analysis Herding and Crashes Markus K Brunnermeier Oxford University Press Jan 2001 KS Browninan Motion and Stochastic Calculus Ionnis Karatzas Steven Shreve Springer Verlag 1991 second edition Other useful reference books are JC Asset Pricing John Cochrane Princeton University Press 2001 BL Probability and Measure Patrick Billingsley Wiley 1995 third edition JI Martingale Methods in Financial Modelling Marek Musiela Marek Rutkowsky Springer Verlag 1998 OH Market Microstructure Theory Maureen O Hara Blackwell 1995 Especially Chapter 6 is relevant for the course Some references for the behavioral finance SH Inefficient Markets An Introduction to Behavioral Finance Andrei Shleifer Oxford University Press 2000 Prerequisites The course is designed for second year Ph D students of the Economics Department who want to specialize in Financial Economics Thorough knowledge of game theory and general equilibrium theory as taught in the first year Microeconomics course is assumed Undergraduate students and auditors may only register for the course after consultation with the instructors Preceptor For additional questions about the course material please contact Glen Weyl Office Dial Lodge 003F e mail eweyl princeton edu Office hours by appointment Glen will go over the homeworks on Tuesday afternoons It would be helpful to send him e mail prior to the precept indicating which issues should be covered in more detail Glen will also hold some review sessions before the exams Course Requirements Grades will be based on the mid term exam 50 and a final exam 50 One can also receive some bonus points Homework Assignments Homework assignments will differ in length and difficulty Problem sets will be posted at the internet We encourage you to work in groups of one to three people A group should only submit a single solution Intellectual interaction with other Ph D students is crucial for becoming a good economist Midterm Will be held on October 25th in class The midterm will cover the first part of the course Final exam Will be held on December 13th in class The final exam will cover the second part of the course Honor Code As mentioned above you can solve some problem sets in groups However group work is not allowed in exams