Foundations of Financial Economics The course

Transcription

1 Foundations of Financial Economics The course Paulo Brito 1 pbrito@iseg.ulisboa.pt University of Lisbon February 16, 2018

2 The course s webpage pbrito

3 The course: main questions What do agents decide in an intertemporal context? What is the effect of an increase in wealth on the equilibrium interest rate? What is risk and how agents decide in a context of risk? What is the difference between individual and aggregate risk? Is insurance possible? How can risk be priced in a macroeconomic perspective? How does the aggregate price of risk relates to asset pricing? How does interest rates relate to distributional issues?

4 Evidence Historical series on RoR, GDP and financial crises Rates of return Financial crises and productivity

5 Evidence Equity premia: there is clearly a price for risk Figure 1: Cumulative returns on US equities, bonds, bills and inflation, In nominal terms In real terms 100,000 10,000 21,766 1, , Equities 9.4% per year Bonds 4.8% per year Bills 3.9% per year Inflation 3.0% per year Equities: return 6.3% p.a. Bonds 1.8% p.a. Bills 1.0% p.a. Source: Elroy Dimson, Paul Marsh, and Mike Staunton, Triumph of the Optimists, Princeton University Press, 2002, and subsequent research Figure 2: Real annualized returns (%) on equities versus bonds and bills internationally, Ita Bel Ger Fra Spa Ire Jap Nor Swi Eur Net WxU Den UK Fin Wld NZ Can US Swe SAf Aus Equities Bonds Bills Source: Elroy Dimson, Paul Marsh, and Mike Staunton, Triumph of the Optimists, Princeton University Press, 2002, and subsequent research 16 / 19

6 Evidence Equity premia: the price for risk is different for different countries Figure 3: Real annualized equity returns (%) in local currency and US dollars, Ita Fra Bel Ger Spa Ire Jap Nor Swi UK Net Fin NZ Den Can US Swe SAf Aus Local real return USD real return Real exchange rate vs USD Source: Elroy Dimson, Paul Marsh, and Mike Staunton, Triumph of the Optimists, Princeton University Press, 2002, and subsequent research. Figure 4: Worldwide annualized equity risk premium (%) relative to bills and bonds, Den Bel Nor Ire Spa Swi Eur WxU Can NZ Swe Net UK Wld US Fin Ger Jap Ita Fra SAf Aus Equity premium vs. bills Equity premium vs. bonds Source: Elroy Dimson, Paul Marsh, and Mike Staunton, Triumph of the Optimists, Princeton University Press, 2002, and subsequent research. Premiums for Germany are based on 109 years, excluding hyperinflationary / 19

7 Evidence UK filtered data: the rate of interest co-moves with the rate of growth Real interest rate, population growth and GDP: UK % year

8 Evidence premiums of the 1990s (and higher equity values) to reduced volatility in real economic variables including employment, consumption and GDP growth. One of the graphs that they use to illustrate the correlation looks at the relationship between the volatility in US: dividend/price volatility and GDP volatility GDP growth and the dividend/ price ratio (which is the loose estimate that they use for equity risk premiums), and it is reproduced in figure 1. Figure 1: Volatility in GDP growth and Equity Risk Premiums (US) 4 Lettau, M., S.C. Ludvigson and J.A. Wachter, The Declining Equity Risk Premium: What role does Figure: in Damodaran (2012) macroeconomic risk play? Review of Financial Studies, v21,

9 The course s objectives Provide an introduction to asset pricing (interest rates and risk) from a aggregative perspective Using a benchmark dynamic general equilibrium (DGE) approach, deterministic and stochastic (DSGE) DGE and DSGE models deal with the interaction between consumption, savings, portfolio investments, and pricing of financial contracts in a general equilibrium context

10 The course s options This is a HUGE field, therefore we have to make choices: we study two-period and multi-period discrete-time versions of a simple benchmark model; we try to get explicit solutions whenever possible we deal (mostly) with endowment economies (i.e, output is given) we provide an introduction to financial frictions and their aggregate effects

11 The course s options We do not deal thoroughly with, but can cover simple cases, v.g : theory of decision making under uncertainty theory of intertemporal decision making under uncertainty financial frictions (v.g., information imperfections and contract theory) corporate finance detailed pricing of financial instruments financial intermediaries (banks) monetary policy open economies and international capital markets financial history dynamics in general: deterministic, stochastic, distributional. computation of DSGE models