Introduction and Subject Outline. To provide general subject information and a broad coverage of the subject content of

Transcription

1 Introduction and Subject Outline Aims: To provide general subject information and a broad coverage of the subject content of Objectives: On completion of this lecture, students should: be aware of the responsibility of the lecturer and the student over the duration of this semester in this subject in terms of preparation for lectures and tutorials, non-compulsory and compulsory assignments and general subject information have a broad overview of the subject content of this subject. Page 1 of 18

2 1. General Subject Information Course Coordinator: Associate Professsor Kalvinder Shields Student Consultation Hours: Thursdays, 3.15pm pm. Course Tutor: Maurice Ng Pit-Stop Tutorial: Tuesday; Time to be advised. Prerequisites: Intermediate Macroeconomics Intermediate Microeconomics and either Introductory Econometrics or Quantitative Methods 2. Page 2 of 18

3 Prescribed Textbook: Bailey, R. E. The Economics of Financial Markets, Cambridge University Press, The course will refer closely to the chapters in this book. Hence, it is important that you devote time each week to study the relevant chapter material. Other Useful References: Cuthbertson, K. and Nitzsche, D., Quantitative Financial Economics: Stocks, Bonds and Foreign Exchange, Second Edition, John Wiley & Sons, New York, Elton, E. J. and M. J. Gruber, Modern Portfolio Theory and Investment Analysis, Wiley, 6th edition, Other additional reading will be given as the course progresses. Page 3 of 18

4 Course Materials: All lecture notes and tutorial sheets will be available from the subject homepage which can be accessed through the LMS system. It is the responsibility of each individual to print these out BEFORE coming to the relevant lecture. Please check regularly for updates to the bulletin board. Tutorials: There will be a one hour tutorial a week, in which the previous week s lectures will be revised in the context of exercises. ALL students are required to attempt these exercises BEFORE coming to the tutorial. There will be answer guidelines provided for all the exercises after the relevant tutorial. However, these guidelines are brief and do not substitute for attendance at the tutorials. Moreover, it s important to understand HOW to do the exercises and not to memorise the answers. Since tutorial participation is compulsory and contributes to 10% of your final mark, it is expected that you will have a good understanding of the answers before you get them! Page 4 of 18

5 Assessment: A 2-hour end-of-semester examination (70% of the final mark). A mid-semester multiple-choice test to be taken in the lectures (10% of your final mark). There will be feedback given on this test in the tutorials. A short assignment to be completed during the course of the semester (10% of your final mark). Active participation in tutorials, including formal group presentations of relevant exercises (10% of your final mark). Page 5 of 18

6 Course Outline: This course is a combination of principle and practice: it provides an overview of the economic principles governing financial markets and provides insights into some important theoretical, empirical and practical issues concerning the operation of financial markets. The approach taken allows an introduction to important applied work in the economic journal literature. Much of this applied work is grounded in some fairly intuitive ideas and the aim is that by the end of the course, students should feel quite comfortable in approaching the original sources in a meaningful way. In addition, through the tutorials, the multiple choice test and the compulsory assignment, students will be required to use quantitative skills to address and increase their understanding of the empirical issues and problems in the economics of finance literature. Hence, students should emerge from the course with an understanding of: how economic theory applies to financial markets; how economic theory imposes testable restrictions on financial data; the main established theoretical and empirical findings for financial markets; Page 6 of 18

7 2. Subject Topics Asset Markets and Asset Prices Predictability of Prices and Market Efficiency Decision Making under Uncertainty Portfolio Selection: The Mean-Variance Model The Capital Asset Pricing Model, CAPM Arbitrage, Factor Models and the APT Empirical Appraisal of CAPM and APT Present Value Relationships & Price Volatility Rational Bubbles Bond Prices and the Term Structure of Interest Rates Page 7 of 18

8 Topics in more detail: I. Asset Markets and Asset Prices. The main types of capital markets. Fundamental principles of asset price determination. Arbitrage. Concepts of asset market efficiency. Required reading: Economics of Financial Markets, chapter 1. Recommended reading: Elton and Gruber: chapters 2 (pp ), 3 (pp ). Cuthbertson and Nitzsche, Chapter 1. Keynes, J. M. The General Theory of Employment, Interest and Money, chapter 12. Supplementary reading: Shiller, Robert J. Irrational Exuberance, Princeton U. Press, 2nd ed., 2005, ch. 1, 3. Page 8 of 18

9 II. Predictability of Prices and Market Efficiency. Random walks of asset prices and martingales. Asset market efficiency and anomalies in asset prices. Event studies. Required reading: Economics of Financial Markets, chapter 3. Recommended reading: Elton and Gruber: chapter 17 (pp ). Cuthbertson and Nitzsche, Chapter 3. Supplementary reading: Malkiel, B. G. A Random Walk Down Wall Street. (W. W. Norton & Co., Revised ed., 2003) chapters 1, 5-7. LeRoy, S. F. (1989), Efficient Capital Markets and Martingales, Journal of Economic Literature, Vol. XXVII, p Fama, EugeneF.(1970), Efficient Capital Markets: A Review of Theory and Empirical Page 9 of 18

10 Work, Journal of Finance, Vol. 25, p Fama, Eugene F. (1991), Efficient Capital Markets II, Journal of Finance, Vol. 46, p Nofsinger, J. R. The Psychology of Investing, (Prentice-Hall, 2002) chapters 4, 5. III. Decision-Making Under Uncertainty. Risk and Uncertainty. State preference analysis. Expected utility hypothesis. Mean-variance analysis. Required reading: Economics of Financial Markets, chapter 4. Recommended reading: Page 10 of 18

11 Any Intermediate Microeconomics Textbook. Elton and Gruber: chapter 10 (pp ). Cuthbertson and Nitzsche, Chapter 1. Supplementary reading: Nofsinger, J. R. The Psychology of Investing, (Prentice-Hall, 2002) chapters 6 9. Eeckhoudt, L., C. Gollier & H. Schlesinger, Economic & Financial Decisions under Risk, Princeton U. Press, 2005, chapters 4, 5. IV. Portfolio Selection: the Mean-Variance Model. The portfolio frontier with two risky assets (and no riskless asset). Inclusion of a riskless asset. Many risky assets. Portfolio separation theorems. Optimal portfolio selection: the mean-variance case. Page 11 of 18

12 Required reading: Economics of Financial Markets, chapter 5. Recommended reading: Elton and Gruber: chapters 4 (pp ), 5 (pp ). Cuthbertson and Nitzsche, Chapter 5. Copeland, T. and Weston, J. (1992), Financial Theory and Corporate Policy, Third Edition, Addison Wesley Publishing Company, Chapter 6. Supplementary reading: Elton and Gruber: chapter 6. Page 12 of 18

13 V. Capital Asset Pricing Model, CAPM. Assumptions of the model and its relationship with portfolio selection. Market equilibrium. Implications of CAPM for individual assets. Portfolio diversification and the market portfolio. Disequilibrium. Extensions: absence of a riskless asset. Required reading: Economics of Financial Markets, chapter 6. Recommended reading: Elton and Gruber: chapters 13 (pp ), 14 (pp ). Cuthbertson and Nitzsche, Chapter 5, 7. Copeland, T. and Weston, J. (1992), Financial Theory and Corporate Policy, Third Edition, Addison Wesley Publishing Company, Chapter 6. Supplementary reading: Perold, A. F. The Capital Asset Pricing Model, Journal of Economic Perspectives, vol. 18 (3), 2004, pp Page 13 of 18

14 VI. Arbitrage, Factor Models and the APT. Arbitrage opportunities and their absence. Factor models of asset markets. Implications of the absence of arbitrage opportunities. Comparison with the CAPM. Required reading: Economics of Financial Markets, chapters 7 and 8. Recommended reading: Elton and Gruber: chapter 16 (pp , ). Cuthbertson and Nitzsche, Chapter 7. Copeland, T. and Weston, J. (1992), Financial Theory and Corporate Policy, Third Edition, Addison Wesley Publishing Company, Chapter 6. Supplementary reading: Varian, H. R. The Arbitrage Principle in Financial Economics Journal of Economic Perspectives vol. 1, Fall 1987, pp Page 14 of 18

15 VII. Empirical Appraisal of the CAPM and the APT. Testing the CAPM and APT using data on asset prices. Methodological problems of testing asset pricing models. Required reading: Economics of Financial Markets, chapter 9. Recommended reading: Cuthbertson and Nitzsche, Chapter 8. Supplementary reading: Fama, E. F. & K. R. French, The Capital Asset Pricing Model: Theory and Evidence, Journal of Economic Perspectives, vol. 18(3), 2004, pp Jagannathan, R. and E.R. McGratten The CAPM Debate, Quarterly Review of the Federal Reserve Bank of Minneapolis Fall 1995, pp A copy of this paper is available at: woodrow.mpls.frb.fed.us/research/qr/qr1941.html. Page 15 of 18

16 VIII. IX. Present Value Relationships and Price Variability and Rational Bubbles Asset prices as Net Present Values. Models of asset price volatility. Extreme fluctuations in asset prices. Required reading: Economics of Financial Markets, chapter 10. Recommended reading: Cuthbertson and Nitzsche, Chapter 10. Shiller, Robert J. Irrational Exuberance, Princeton U. Press, 2nd ed., 2005, chapters 10, 11, 12. Supplementary reading: Garber, P. Famous First Bubbles, Journal of Economic Perspectives, 1990, vol. 4, No. 2, pp Malkiel, B. G. A Random Walk Down Wall Street. (W. W. Norton & Co., Revised ed., Page 16 of 18

17 2003) chapters 2, 4. Kindleberger, C. P. Manias, Panics and Crashes, Macmillan, 1978, chapters 3, 4, 5. Froot, K. A. and M. Obstfeld (1991), Intrinsic Bubbles: The Case of Stock Prices, The American Economic Review, Vol. 81, 5, p Barberis, N. and R. Thaler, (2003), A Survey of Behavioural Finance, Chapter 18 in Handbook of the Economics of Finance, ed. G. M. Constantinides, M. Harris, R. Stulz, Elsevier Science B.V., available at 6.pdf. X. Bond Prices and the Term Structure of Interest Rates. Bond pricing, yields and yield curves. Theories of the term structure of interest rates and empirical evidence on the term structure of interest rates. Page 17 of 18

18 Required reading: Economics of Financial Markets, chapter 12,13. Recommended reading: Cuthbertson and Nitzsche, Chapter 20, 21, 22. Felmingham, B. and W. Coleman, Money and Finance in the Australian Economy, First Edition, Irwin, Chapter 9. Supplementary reading: Mishkin, F.S. (1990), What does the term structure tell us about future inflation?, Journal of Monetary Economics, Vol 88, 2, p Taylor, M.P. (1992), Modelling the Yield Curve, Economic Journal, Vol 102, p Page 18 of 18