GRA 6517 Theory of Financial Markets
GRA 6517 Theory of Financial Markets
The course looks at the purpose of finance and the role of financial markets in an economy. A big part of this theory looks at how asset prices are determined, which begins with Markowitz’s portfolio theory and the Capital Asset Pricing Model (CAPM). We then move on to more theories: Merton’s Intertemporal CAPM, Consumption CAPM and the Arbitrage Pricing Theory. These theories allows us to examine the efficiency of financial markets in view of their role. We then look at how investor behavioural biases may affect the workings of financial markets and close with the fundamentals of pricing contingent claims. The course is rigorous and requires good knowledge of basic calculus and linear algebra. Nevertheless, each topic includes and is motivated by real life examples to be able to relate theory with practice.
At the end of the course, the students should be able to understand the theory of financial markets and apply the asset pricing models in practice.
Acquired Knowledge
The students at the end of the course are expected to know
- The role and value of financial markets in an economy
- The concept of the efficiency of the financial markets and how this is connected with their role
- Why asset pricing and understanding the relation between return and risk is fundamental in finance
- The classical asset pricing theories: CAPM and APT
- The connection between consumption risk, consumption and investment choices and the risk-return relation
- The fundamental theorem of asset pricing, i.e. the connection between arbitrage, the law of one price and linear pricing.
- How information aggregates in a financial market
- Certain market imperfections and failures
The students at the end of the course are expected to be able to
- Implement the classical mean-variance analysis for portfolio selection
- Use different pricing concepts (e.g. state prices) and models (e.g. CAPM, CCAPM, APT) to price fundamental securities and contingent claims
The students at the end of the course should be able to understand the assumptions, limitations and applicability of the various asset pricing models and concepts. Also, the students should be able to critically evaluate the various assumptions and hypotheses, in view of the known market imperfections and in relation to the efficiency and role of financial markets.
Part I: Fundamentals
- The role of financial markets and institutions
- Consumption, production and investment decisions
- Fundamental valuation and market efficiency
Part II: Portfolio choice and linear factor models
- Mean-variance portfolio choice
- Capital Asset Pricing Model
- Arbitrage Pricing Theory
Part III: Principles of asset pricing
- Consumption and Intertemporal CAPM
- State-preference theory
- Risk-neutral pricing
Part IV: Market imperfections
- Asymmetric information
- Behavioral theory and limits to arbitrage
Lectures (class participation and problem solving is essential.)
Please note that while attendance is not compulsory in all courses, it is the student’s own responsibility to obtain any information provided in class that is not included on the course homepage/itslearning or text book.
All parts of the assessment must be passed in order to get a grade in the course.
Excel and Bloomberg will be used.
All courses in the Masters programme will assume that students have fulfilled the admission requirements for the programme. In addition, courses in second, third and/or fourth semester can have specific prerequisites and will assume that students have followed normal study progression. For double degree and exchange students, please note that equivalent courses are accepted.
| Assessments |
|---|
Exam category: Submission Form of assessment: Written submission Invigilation Weight: 30 Grouping: Individual Support materials:
Duration: 2 Hour(s) Comment: Mid-term written examination with supervision Exam code: GRA65171 Grading scale: ECTS Resit: Examination when next scheduled course |
Exam category: Submission Form of assessment: Written submission Invigilation Weight: 70 Grouping: Individual Support materials:
Duration: 3 Hour(s) Comment: Final written examination with supervision Exam code: GRA65172 Grading scale: ECTS Resit: Examination when next scheduled course |
All exams must be passed to get a grade in this course.
A course of 1 ECTS credit corresponds to a workload of 26-30 hours. Therefore a course of 6 ECTS credits corresponds to a workload of at least 160 hours.