Objectives

This is an intermediate course on asset pricing, portfolio choice and investment theory. The course will cover fundamental theory as well as practical implications, in three parts.

In the first part, on investor preferences and portfolio choice, we introduce the micro foundation for how investors make choices under uncertainty. Our main focus is on the neoclassical von Neumann-Morgenstern expected utility setting, but we will also discuss several rational and behavioural modifications and extensions.

In the second part of the course, we study equilibrium asset pricing theory, introducing classical models like the Capital Asset Pricing Model (CAPM) and the Consumption-based CAPM (CCAPM). In addition to covering theory, we discuss the major implications for investors, e.g., with respect to diversification, systematic versus idiosyncratic risk, and consumption smoothing. We will also discuss several challenges for the theory, for example, the equity premium puzzle, the risk-free rate puzzle, and the excess volatility puzzle.

In the third and final part of the course, we study (no-) arbitrage theory, and its powerful applications to financial markets, e.g. the, markets for derivatives and bonds. We discuss the relationship between no-arbitrage and existence of risk-neutral pricing (or, equivalently, so-called stochastic discount factors). We also cover the Arbitrage Pricing Theory (APT). Finally, we discuss some exciting recent developments within asset pricing.

Contents

• Introduction to Asset Pricing
• Decision-making under Uncertainty
• Mean-Variance Analysis
• Capital Asset Pricing Model
• Empriical Evidence
• State Prices & the Arrow Debreu Economy
• Consumption CAPM
• Risk-neutral Pricing
• Arbitrage Pricing Theory & the Factor Zoo
• Consumption-based Asset Pricing

References

• Lecture slides, additional materials, and exercises provided during the course
• Intermediate Financial Theory, 3rd Edition, by Jean-Pierre Danthine and John B. Donaldson, Academic Press/Elsevier, 2015. (Main Textbook)
• Asset Pricing, Revised Edition, by John Cochrane, Princeton University Press, 2005.
• Dynamic Asset Pricing Theory, 3rd edition, by Darrell Duffie, Princeton University Press, 2001.
• Arbitrage Theory in Continuous Time, 3rd Edition, by Tomas Björk, Oxford University Press, 2009.

Pre-requisites

A good understanding of calculus and probability theory is required.

Evaluation

First attempt

Exam:

Written 2h00 hours

Documentation:

Not allowed

Calculator:

Allowed

Evaluation:

The overall course grade is based on midterm and final exam performances and is calculated as follows:

- 0.7 x Final Exam Grade + 0.3 x Midterm Exam Grade

In case a student cannot attend the midterm exam the overall course will be equal to the grade achieved in the final exam.

Retake

Exam:

Written 2h00 hours

Documentation:

Not allowed

Calculator:

Allowed

Evaluation:

The overall course grade will be based entirely on the retake final exam performance.