Objectives

Course objective: Information is at the heart of the economy today. Despite this, there is still a lively debate over whether markets aggregate the dispersed information of agents in the economy or whether they are at the mercy of herd behavior and fads and in the hands of short-term speculators and insiders. The debate has old roots and goes back at least to the exchange between Hayek and Lange in the 1930s about the economic viability of socialism. While Lange (1936, 1937) argued that socialism was viable because a competitive allocation can be replicated by a central planner, Hayek contended that the superiority of markets was to be found in their ability to aggregate the dispersed information of agents in the economy (Hayek, 1945). In contrast to Hayek, Keynes in his General Theory pioneered the view of the stock market as a beauty contest where investors try to guess average opinion, instead of fundamentals, and end up chasing the crowd (Keynes, 1936).

The central issue is whether we can trust markets to aggregate information in a world where information is dispersed. Does the stock market reflect the underlying fundamentals of the traded firms? Or, to put the question in more concrete terms, does the price in the futures market for gas aggregate the relevant information of producers and speculators?

In this course we will analyze in depth the information aggregation properties of markets and the impact of specific trading arrangements (the market microstructure) on the information aggregation process and the quality or performance of the market. We will explore some of the latest research questions and theories designed to address those questions. We will use information frictions and information choice as a way to reconcile standard theory with puzzling facts. At the same time as we explore theory, we will be building up the tools of Bayesian updating and Bayesian forecasting, powerful tools to address many questions that arise in the business world as well.

Teaching fellow: Zhimin Chen zhimin.chen@unil.ch

Contents

Main topics:

1. Trading mechanisms
2. Eficient market hypothesis
3. Public and private information
4. Noisy rational expectations models
5. Insider trading models
6. Herding models: the case of Gamestop
7. Market microstructure and asset pricing (if time allows)

References

Articles: Posted on Moodle

Primary Textbook:

1. Laura Veldkamp, "Information Choice in Macroeconomics and Finance", Princeton University Press
2. Joel Hasbrouck, "Empirical Market Microstructure", Oxford University Press, 2007.

Other Useful References:

1. Thierry Foucault, Marco Pagano, Ailsa Roell, "Liquidity: Theory, Evidence, and Policy", Oxford University Press, 2013.
2. William F. Sharpe, “Investors and Markets”, Princeton University Press, 2007.
3. Yakov Amihud, Haim Mendelson, Lasse Heje Pedersen, “Market Liquidity”, Cambridge University Press, 2013.

Pre-requisites

1. Mathematics for Economics and Finance
2. Introduction to Finance

Evaluation

First attempt

Exam:

Without exam (cf. terms)  

Evaluation:

Grading: Your grade will be determined by the following:

• Tutorials (in group) 40%
• Final take-home project (in group) 60%

Tutorials: There will be 3 tutorial sessions during class-time where you will have the opportunity to practice different problems in groups and with the help of your TA. At the end of each tutorial, you will hand in your work to be graded. There are no make-ups for the tutorials.

Final Exam: There will be a final group project due in the last week of class. The final exam is open-book, no restrictions, cumulative and you will have a week to work on it with your group.

Retake

Exam:

Without exam (cf. terms)  

Evaluation:

In case the group fails the 1st attempt, they will have the possibility to retake the final exam during the retake session. The final exam is open-book, no restrictions, cumulative and the group will have a week to work on it.