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Asset Pricing(HON109)  Universityof International Business and Economics

 

ProfessorWeixing WU

Professor Mei Yu

Associate Professor Yanmei Sun

Associate Professor Haibin Xie.

Tel：010-64492670

E-mail：wxwu@uibe.edu.cn.

 

Course Office:Boxue 902, No.10 Huixindongjie, Chaoyang District, Beijing, China

The office is open from 8:30 - 5:00 Monday through Friday. Our email address is: wxwu@uibe.edu.cn.

 

Syllabus：

Course Description:

 

This course provides some of the tools necessary to approach the asset pricing literature, both theoretical and empirical, from a modern perspective. To different degrees, these tools are all related to the basic notion of no-arbitrage. We first defined the basic notation and definitions of a discrete-time stochastic security market, in the general case in which the support of prices and dividends is not restricted to be finite. We then formalize the intuitive notion of no-arbitrage from different perspectives, and we show how these formalizations lead to the characterization of no-arbitrage in terms of linear pricing rules, of stochastic discount factors, and of equivalent martingale measures. We then go on to relate the characterization of no arbitrage to the work horses of finance theory, i.e. the mean variance frontier and linear factor models. This course should also allow the students both to make a natural transition to the study of asset pricing in continuous-time, and as a foundation for advanced courses in empirical asset pricing and corporate finance.

 

 

Course Materials:

 

The course will follow most closely my lecture notes, which I will hand out in class.  The following two required texts provide important supplementary reading. 

• Required Texts:  
  • Stephen F. LeRoy and Jan Werner, Principles of Financial Economics, Cambridge University Press, 2001. (LW)
  • Chi-Fu Huang and Robert H. Litzenberger, Foundations for Financial Economics, Prentice-Hall, 1988. (HL) 
• Recommended References:
  • John E. Ingersoll, Jr., Theory of Financial Decision Making, Rowman and Littlefield, 1987. (I)
  • John H. Cochrane, Asset Pricing, Princeton University Press, 2001.(C) 
• Restricted access course materials will be available online. 

Tentative Course Outline:

 

Listed articles will be available on the class website with restricted access. This outline will be updated throughout the semester. Please consult the class website for updates.

 

 

Topic 1. Expected Utility Theory and Risk Aversion 

• Expected utility
• Risk Aversion
• Readings
  • LW 8-9
  • HL 1

 

Pratt, J.W., Risk Aversion in the Small and in the Large, Econometrica, 32, 122-136, 1964.

 

Starmer, C., Developments in Non-Expected Utility Theory: The Hunt for a Descriptive Theory of Choice under Risk, Journal of Economic Literature, 38:332-382, 2000.

 

Topic 2. Discrete-Time Asset Valuation: Two-Period 

• Arrow-Debreu economy and state-contingent claims
• Composite security and arbitrage
• Risk-neutral pricing and equivalent martingale measure
• Risk sharing and Pareto optimality 
• Aggregation
• Corporate finance in A-D economy
• Readings 
  • LW 4-7
  • HL 5

 

 

Arrow, K.J., The Role of Securities in the Optimal Allocation of Risk Bearing, Review of Economic Studies, 31, 91-96, 1964.

 

Ross, S.A., A Simple Approach to the Valuation of Risky Streams, Journal of Business, 51, 453-475, 1978.

 

Topic 3. Options: An Example of Arbitrage Pricing 

• Some arbitrage pricing relations on options
• American option and early exercise
• Pricing options in complete markets
• Options on aggregate consumption and market completeness
• Pricing options with preference restrictions
• Readings 
  • LW 1-3
  • HL 6

 

Breeden, D.T. and Litzenberger, R. Prices of State-Contingent Claims Implicit in Option Prices. Journal of Business, 51, 621-651, 1978.

 

Ross, S.A., Options and Efficiency. Quarterly Journal of Economics, 90, 75-89, 1976.

 

 

Topic 4. Portfolio Choice 

• Portfolio choice and risk aversion
• Portfolio separation theorems
• Readings
  • LW 11-13 
  • HL 4

 

Cass and Stiglitz, The Structure of Investor Preferences and Asset Returns, and Separability in Portfolio Allocation, Journal of Economic Theory, 2, 122-160, 1970. 

 

Topic 5. Mean-Variance Analysis 

• Foundations of M-V analysis
• Mean-Variance efficient portfolios
• Properties of M-V efficient portfolio
• The case with risk-free asset
• Readings
  • LW 14-15, 17-18
  • HL 3

 

Topic 6. Capital Asset Pricing Model (CAPM)

• Zero-beta CAPM
• Traditional CAPM
• CAPM as a G.E. result: CARA & normal payoff & risk-free asset
• CAPM as a G.E. result: normal return & risk-free asset
• CAPM as two-fund separation
• Readings 
  • LW 19
  • HL 4

 

 

Topic 7. Arbitrage Pricing Theory (APT) 

• Exact factor models and APT
• Limiting arbitrage and APT
• Risk and premium in APT
• Limiting arbitrage and equilibrium
• Readings 
  • LW 20
  • HL 4

Connor, A Unified Beta Pricing Theory, Journal of Economic Theory,34, 13-31, 1984.  

Chamberlain, G. and Rothschild, M., Arbitrage, Factor Structure and Mean Variance Analysis in Large Asset Markets. Econometrica, 51, 1281-1304, 1983. 

Huberman, G., A Simple Approach to Arbitrage Pricing Theory. Journal of Economic Theory, 28, 1183-1191, 1983. 

Ross, S.A., The Arbitrage Theory of Capital Asset Pricing. Journal of Economic Theory, 13, 341-360, 1976. 

Shaken, J., The Current State of the Arbitrage Pricing Theory. Journal of Finance, 47:1569-1574, 1992. 

 

Topic 8. Discrete-Time Asset Valuation: Multi-Period 

• Optimal investment-consumption strategies
• Equilibrium pricing
• Asset pricing by arbitrage
• Readings
  • LW 14, 21-28,
  • HL 7-8

 

Breeden, D.T., An Intertemporal Asset Pricing Model with Stochastic Consumption and Investment Opportunities. Journal of Financial Economics, 7:265:96, 1979.

 

Cox, J.C., Ross, S.A. and Rubinstein, M., Option Pricing: A Simplified Approach. Journal of Financial Economics, 7, 229-263, 1979.

 

Lucas, R.E. Asset Prices in an Exchange Economy. Econometrica, 46:1429-45, 1978.

 

Merton, R., An Intertemporal Capital Asset Pricing Model. Econometrica, 41:867-887, 1973.

 

Radner, R. Existence of Equilibrium of Plans, Prices and Price Expectations in a Sequence Economy, Econometrica, 40, 289-303, 1972.

 

 

Topic 9. Financial Markets with Imperfections 

• Market incompleteness
• Asymmetric information
• Financial constraints and frictions
• Readings 
  • LW 4, 16
  • HL 9

 

He, H. and Pearson, N., Consumption and Portfolio Policies with Incomplete Markets and Short-Sale Constraints: The Finite Dimensional Case, Mathematical Finance, 1:1-10, 1991. 

 

Grossman, S., An Introduction to the Theory of Rational Expectations under Asymmetric Information, Review of Economic Studies, 48, 573-585, 1981.

Grossman, S. and J. Stiglitz, On the Impossibility of Informationally Efficient Marekts, American Economic Review, 70, 393-408, 1980.

 

Kyle, A., Continuous Auctions and Insider Trading, Econometrica,53, 1315-1335, 1985. 

 

Constantinides, G., Capital Market Equilibrium with Transaction Costs, Journal of Political Economy, 94, 842-862, 1986.  

 

Davis, M. and A. Norman, Portfolio Selection with Transaction Costs, Mathematics of Operations Research, 15, 676-713, 1990. 

 

Grossman, S. and G. Laroque, Asset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumption Goods, Econometrica,58, 25-52, 1990. 

 

SCHEDULE

 

Class	Date	Topic	Text /Ed2	Deliverables
1	Wed, March. 3	Expected Utility Theory and Risk Aversion	LW 8-9 HL 1
2	Wed, March. 10	Discrete-Time Asset Valuation: Two-Period	LW 4-7 HL 5
3	Wed, March. 17	Options: An Example of Arbitrage Pricing	LW 1-3 HL 6
4	Wed, March. 24	Portfolio Choice: Portfolio choice and risk aversion	LW 11-13  HL 4 LW 11-13  HL 4
5	Wed, March. 31	Portfolio Choice: Portfolio separation theorems
6	Wed,. Apr. 7	Mean-Variance Analysis	LW 14-15, 17-18 HL 3
7	Wed,. Apr. 14	Capital Asset Pricing Model (CAPM)	LW 19 HL 4
8	Wed,. Apr. 21	Arbitrage Pricing Theory (APT)	LW 20 HL 4
9	Wed,. Apr. 28	Discrete-Time Asset Valuation: Multi-Period  1.General Setting	LW 14, 21-28, HL 7-8	Short Paper 1
10	Wed,. May. 5	Discrete-Time Asset Valuation: Multi-Period 2. Optimal investment-consumption strategies
11	Wed,. May. 12	Discrete-Time Asset Valuation: Multi-Period 2.Equilibrium pricing
12	Wed,. May. 19	Discrete-Time Asset Valuation: Multi-Period 3. Asset pricing by arbitrage
13	Wed,. May. 26	Financial Markets with Imperfections: introduction	LW 4, 16 HL 9	Short Paper 2
14	Wed,. June. 2	Financial Markets with Imperfections: Market incompleteness
15	Wed,. June. 9	Financial Markets with Imperfections: Asymmetric information		Empirical Paper
16	Wed,. June. 16	Financial Markets with Imperfections: Financial constraints and frictions
17	Wed,. June.23	Presentation and Discussing		Final Paper
18	Wed,. June. 30	Review

 

 

Course Requirements:

 

Class Participation:  35% of grade. Attendance is mandatory. 

 

Short Papers.  20% of grade. Two short papers (3-4 pages, double-spaced).  One of the papers will be a literature summary of one of the major strands of finance. The other paper will be either: a short empirical study of an asset price phenomena of interest, or a short paper relating asset pricing theory to an event in financial history.

 

Empirical Paper.  15% of grade. This paper will require you to conduct statistical tests on a phenomena of interest and report the results.  It will be expected that your statistical tests are well motivated by theory.

 

Final Paper.  30%.  4-6 pages, double-spaced.  You will be given several different options for your final paper. It can be expected that all of the options will involve some data work.

 

 

Course Policies:

 

Attendance. Attendance is mandatory at all regular class meetings.  Exceptions for personal or family emergencies will be granted on a case-by-case basis. 

 

Tardiness. No assignment will be accepted beyond the announced deadline.  As with attendance, exceptions for personal or family emergencies will be made on a case-by-case basis.  

 

Office hours.  I will be available for office hours for 30 minutes after every class.  If additional time is needed, please email me at wxwu@uibe.edu.cn.