EC500 Microeconomics and EC502 Macroeconomics
OverviewThe module develops your skills in asset pricing and your understanding of the theoretical basis of the theory behind it. The module stresses practical training in asset pricing.
There are three key topics; (i) investors' optimisation, (ii) discrete time models and (iii) option Greeks and option strategies. For (i), the module first introduces the basic financial economics, and, based on it, we establish the basis of the risk-neutral probability. For (ii), the module discusses how to construct the tree model based on the historical price data, and shows that the model can be used to find the fair prices of a wide range of financial derivatives. For (iii), the module investigates the Black-Scholes-Merton (BSM) formula, and then how to use it to find the optimal hedge ratio for delta hedging. In this respect, the module also discusses how to use the return correlations to find the optimal hedge ratio.
Although the module requires some mathematical techniques, its main aim is to offer training to obtain some practical skills. Hence, the module puts stress on the intuitions and heuristics behind theorems and formulae, rather than their rigorous derivations and semantic definitions. In addition, you are expected not only to understand theories but are also to master how to use them. Indeed, you are expected make frequent use of a calculator in the final exam and the term-time assessment in order to obtain actual numbers from historical stock price data.
There are no pre-requisites for this module but the following modules are recommended: EC534(Money and Banking), EC550(Monetary), EC548(international Finance), EC562(Finance 2).
This module appears in:
1 computer terminal session
Method of assessment
20% In Course Test (2 x 10%)
80% Examination (2 hours)
By the end of the module, you will:
??understand the basic concepts and issues in the financial economics
??understand the equivalence among no-arbitrage, investors' optimisation and risk-neutral probability, which is the theoretical justification of the use of the risk-neutral probability
??be able to construct a proper tree model to find the fair price of a non-standard financial derivative, given the historical price data of its underlying asset
??be able to use the Black-Scholes-Merton model for the delta hedge
??be able to find the optimal hedge ratio based on the empirical return correlations
??be able to construct a proper option strategies for various occasions
??become more familiar with financial data and numerical computation