Lectures on Financial Economics


Download (> 850 pages)  — Last update: February 26th, 2017

This book manuscript originates from notes I wrote in support of advanced undergraduate and graduate lectures in financial economics, macroeconomic dynamics, financial econometrics and financial engineering. It contains three parts, which I describe very broadly below. The Preface contains a great deal of details and motivation regarding these lectures. I would highly recommend the reader to refer to the Preface for a much better introduction to these lectures than the streamlined description below.

“Part I: Foundations” provides primordial tools of analysis and the historical context underlying the analysis in more advanced parts of the book. It deals with such disparate topics as classical portfolio selection, option pricing, dynamic consumption- and production- based asset pricing, in both discrete and continuous-time, the intricacies underlying incomplete markets and other market imperfections and, finally, some standard but also relatively more modern methods of statistical inference.

“Part II: Empirical lessons and market inefficiencies” is about explaining the main empirical facts and the challenges these facts pose to financial economists: from excess price volatility and countercyclical stock market volatility, to cross-sectional puzzles such as the value premium. To illustrate, this Part reviews models in which agents face idiosyncratic risk, Knightian uncertainty, have heterogenous beliefs and learn about their ever-changing environment, face financial constraints, invest in assets subject to bubbles, or generate feedback effects (from capital markets to business cycle developments). This Part also addresses core questions regarding market inefficiencies, limits to arbitrage, asymmetric information, or the organization of markets.

“Part III: Asset pricing and reality” aims just to this: to rely on the lessons drawn from Part II (through the main analytical tools in Part I) and cope with the main challenges posed by actual capital markets, arising from option pricing and trading, interest rate modeling, or credit risk and the associated derivatives. In a sense, Part II is about the big puzzles we face in fundamental research, while Part III is about how to live within our current and certainly unsatisfactory paradigms, so as to cope with demand for intellectual expertise.

This manuscript is still incomplete. Economic motivation and intuition are not always developed as they would deserve, some derivations are inelegant and, sometimes, the presentation is still a bit informal. Moreover, I still have to include material on monetary models of asset prices, theories of the nominal and the real term structure of interest rates, bubbles, asset prices implications of overlapping generations models, theories of decentralized markets, limits to arbitrage, agency problems in continuous time, or financial frictions and their interconnections with business cycle developments. Finally, I need to include more extensive surveys for each topic I cover, especially in Chapters 1, 3, 5, 6, and 10. Of the 13 Chapters I have already drafted, Chapter 6 (and the Preface!) are those in need of the most serious revamp. I am working towards revising these notes and filling these gaps. Meanwhile, any comments on this version of my work are more than welcome.