This course aims to introduce students to the microeconomic foundations of methods for valuing financial assets. Based on microeconomic tools (general competitive equilibrium, vNM utility function, risk aversion) and the foundations of finance (law of one price, absence of arbitrage opportunities), the course aims to establish rigorously and discuss models for asset valuation (and in particular the Capital Asset Pricing Model). The developments examined will help students better understand the concept of arbitrage, the link between real probabilities and risk-neutral probabilities, the role of risk aversion in portfolio choice, the notion of diversifiable and non-diversifiable risk, the role of discounting in uncertain situations. The conclusions of the CAPM (optimal portfolios, risk sharing) will be discussed with regard to uses in businesses and financial institutions. Finally, a sequence will be devoted to empirical data and revealing the variances between microeconomic and market data. The course is designed for students who wish to acquire a strong understanding of the markets and a solid base in corporate and market finance. It will also be useful for students interested in financial macroeconomics.
- Problems in financial economics- Choice of portfolio; evaluating the price of an asset; corporate financing; weighted average cost of capital.
- Financial economics- Assets; complete/incomplete market; price functional; law of one price; absence of arbitrage opportunities; fundamental theorem of finance.
- Individual choices and optimal portfolios- Von Neumann-Morgenstern; measuring risk, tolerance; HARA utility functions; choosing a portfolio with one or more assets.
- Equilibrium and representative agent- Contingent economics; Arrow-Debreu assets; financial economics and Radner equilibrium; Pareto optimality, representative agent.
- Individual valuation of payment profiles- Ideal asset; stochastic discount factor; case of a mean/variance utility function.
- Capital Asset Pricing Model (CAPM)- Price of time and risk; security market line; interpretation (non-diversifiable risk).
- Discussion and extensions- Applications of the results; beta and alpha of an asset; the Equity Premium Puzzle; extension (stochastic financial economics).
Lengwiler Y. (2004), Microfundations of financial Economics, Princeton Series in Finance.
LeRoy S. et Werner J. (2001), Principles of Financial Economics, Cambridge University Press.
Duffie D. (2001), Dynamic Asset Pricing Theory, Princeton University Press.