OverviewThis module provides an overview of the main instruments in financial markets, the motivation for trade in these assets and the pricing of these assets. Specifically, we show how the economics of uncertainty motivates trade in a wide range of financial assets. This helps us determine how the risk and maturity of different assets affects the demand for those assets.
First, the module introduces the key principles of asset pricing: discounting, diversification, arbitrage and hedging. Second, the module introduces and motivates the use of debt, equity and derivative instruments in financial markets. Third, the module applies the key principles of asset pricing to help understand the behaviour of prices across these asset classes. While different classes of assets expose their holders to different types of risks, the key principles of asset pricing are common to all asset classes. This concept is formalised by the Fundamental Theorem of Asset Pricing.
While focusing on financial applications, the module does speak more widely to methodological challenges encountered when testing economic theories against data. These challenges are particularly relevant in financial economics. While the literature has developed a range of innovative techniques to more effectively test competing theories against the data, the answers to a number of key questions remain contested.
This module appears in:
3 drop-in sessions
This module is compulsory for BSc Financial Economics and BSc Financial Economics with Econometrics.
This module is an elective for all other Single and Joint Honours degree programmes in Economics.
This module is not available to students across other degree programmes in the University.
Method of assessment
Problem Sets (15%)
Coding Exercise, (15%)
Examination, 2 hours (70%)
Bailey, R.E. (2005), The Economics of Financial Markets, Cambridge University Press.
Bernstein, P.I. (1996), Against the Gods - the Remarkable Story of Risk, John Wiley.
Campbell, Lo and MacKinlay (1997) The Econometrics of Financial Markets, 1st ed., Princeton University Press.
Fabozzi, Neave and Zhou (2012) Financial Economics, 1st ed., Wiley & Sons.
Hull, J.C. (2006), Options, Futures, and Other Derivatives, 6th ed., Prentice Hall.
By the end of the module, you will be able to:
* understand and critically evaluate the role of economic models in testing market efficiency hypotheses.
* demonstrate knowledge and understanding of the two main approaches to asset pricing in finance and their relative strengths and weaknesses.
* understand the link between the risk profile of an asset and the equilibrium expected return of that asset.
* synthesise and critically compare different financial economic analyses of a financial issue.
* solve analytical, numerical and computational problems relevant to the working of financial markets.
* understand the motivation for trade in common types of financial contracts.