Prof. Markus K. Brunnermeier ©   Princeton University
e-mail: markus@princeton.edu   Econ 525: Financial Economics I
http://www.princeton.edu/~markus   http://courseinfo.princeton.edu
Office: 312 Fisher Hall

Office Hours: after class or Th. 4:30 - 6:00

(subject to change)

   Room B-06 Fisher Hall

Mo. & Wed., 4:15- 5:45 p.m.

Fall 1999

 

ECON 525: Financial Economics I


PRELIMINARY





Aim of the Course:

This course is the first of a sequence of two courses in Financial Economics. Professor José Scheinkman will teach Financial Economics II next spring term. His part will focus on continuous time finance and derivative pricing. 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 assumes that all market participants have the same information, while the second part of focuses on models where different market participants have different information. Introducing asymmetric information allows us to explain stock market crashes, herding, bubbles and Keynes' Beauty contest comparison etc.

Structure of the Course:

PART I: ASSET PRICING UNDER SYMMETRIC INFORMATION

  1. Some Background: Event Tree, Partitions, Filtrations, Probability Space
  2. One period model
  1. Multi-period model
  2. Portfolio Theory, Efficient Frontier and Beta-Pricing
  3. Risk Preferences - Stochastic Dominance
  1. Fund Separation and Aggregation: Utility and Distributional Restrictions
PART II: ASSET PRICING UNDER ASYMMETRIC INFORMATION
  1. Modeling Information
  1. Bayesian Nash Equilibrium vs. Rational Expectations Equilibrium
  2. Information Revelation and Market Completeness
  1. No-Trade Theorems
  2. Bubbles
  1. Classification of Market Microstructure Models - Auctions
  1. Technical Analysis in Dynamic Models
  2. Endogenous serial correlation and the Infinite Regress Problem
  3. Herding and Informational Cascades
  4. Stock Market Crashes
  5. Investigative Herding and Keynes' Beauty Contest
  6. Firm's Short-termism
  7. Bank Runs and Financial Crisis
The end of the course is endogenous. Given the long list of topics, it is possible but not likely that we reach topic 13.
 
 

Textbooks:

As outlined above, the course is divided in two parts. The first part covers the basic principles of asset pricing and portfolio theory. There are many books, which cover this part of the lecture. Each book has its strength and weaknesses.

JC Asset Pricing, John Cochrane,

You can download it for free from the web.

http://gsbwww.uchicago.edu/fac/john.cochrane/research/Papers/Finbook.pdf

This manuscript is very illustrative and the lecture will be partly based on it.

 MQ Theory of Incomplete Markets, Magill & Quinzii, MIT Press 1996 The focus of this book is on general equilibrium analysis than on finance. It provides a very good graphical illustration of the major results. Part of the lecture will be based on this book.
 
  HL Foundations for Financial Economics, Huang & Litzenberger, Prentice Hall 1988 This book is the most popular standard text, but it is a little bit obsolete by now. JI Theory of Financial Decision Making, John Ingersoll, Rowman & Littlefield 1987 This is a very well structured book and thus a good reference. DD Dynamic Asset Pricing Theory, Darrell Duffie, Princeton University Press, 1996, second edition, The first section(s) of this book coincides with the first part of the lecture. It provides a very concise overview. This book focuses on continuous time finance. Therefore, it also is a good investment for next term. CLM The Econometrics of Financial Markets, Campbell, Lo & MacKinlay, Princeton University Press 1997 This is a great book in Financial Econometrics. It also provides some intuitive illustration of the theory. The second part deals with asset pricing under asymmetric information. I am currently writing on a book, on which this lecture will be based.

MB Prices and Information in Financial Markets: Theoretical Models Explaining Bubbles, Technical Analysis, Herding and Crashes,

Markus K. Brunnermeier, Oxford University Press, forthcoming

I will distribute a preliminary version of the chapters of this forthcoming book (Alternatively you can also download it from the web, http://courseinfo.princeton.edu). These chapters won't cost you anything in dollar terms but they won't be free. I hope that you will study them very carefully and make many useful suggestions, catch typos etc. You might also consult

OH Market Microstructure Theory, Maureen O'Hara, Blackwell 1995

Especially Chapter 6 is relevant for the course. 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 instructor. ECON 412 offers a less technical alternative for undergraduate students in spring 2000.

Course Requirements:

Grades will be based on homework assignments (20 %), mid-term exam (35 %), and a final exam (45 %). One can also receive some bonus points.

Homework Assignments

Homework assignments will differ in length and difficulty. Consequently their percentage grades carry different weight. Problem sets will be posted at the internet (http://courseinfo.princeton.edu). They will be graded at random, so be prepared to submit each assignment. I 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 becomes a good economist.) You can submit the problem sets up to 3 days late. You face a penalty of 50 % for each day you are late, i.e. one day late 50 % discount, two days late, 75 % discount. Please put them in my mailbox before 2.00 p.m.

Midterm

Will be held on 15th or 22nd of November (subject to change) in class.

Final exam

The final exam will probably be in form of a 'take home exam'. The final exam will test all topics of the course. It will also force you to build your on (small) model for a posted (general) question. The intention of the final is not only to test your understanding of the covered material but also to smooth the transition from coursework to actual research.

Honor Code

As mentioned above you can solve some problem sets in groups. However, group work is not allowed in exams!