Microeconomics (for Finance)
PROFESSOR FERDINANDO COLOMBO
COURSE AIMS
The course makes use of the findings of microeconomic theory in order to provide
students with an in-depth understanding of the theoretical fundamentals of modern
financial economics.
By the end of the course, the student should have become completely familiar with:
the concepts of risk and positioning with respect to risk; the acquisition of new
information and the corresponding updating of credentials; the benefits of
diversification,; the markets' capacity to facilitate trades that otherwise would be
difficult to carry out; several psychological factors that sometimes inhibit the
capacity to make perfectly rational financial decisions.
COURSE CONTENT
– Risk and uncertainty. von Neumann-Morgenstern and Savage theorems.
Regulatory and/or positive validity of the theory of expected utility. (VZ 1-19,
24-39).
– Uncertainty and beliefs. a priori probability, acquisition of information and
Bayes theorem: theory and numeric simulations. Imitation and information
cascades. (VZ 41-55; RM 1-18, 25-27, 37-38; BS 279-293).
– Risk and return. expected value, equivalent of certainty, risk premium and
probability premium. Coefficients of absolute and relative risk aversion.
Stochastic dominance. Average-variance approach:
criticisms and
justifications. Risk-return trade-off. (VZ 39, 19-24, 65-87; DD 35-38, 57-73,
96-98).
– Investment, insurance and savings decisions: correlation between assets and
benefits of diversification; portfolio selection in the presence of risk and riskfree securities with respect to an individual's wealth and risk aversion.
Efficient risk distribution and insurance contracts. Investment selection and
consumption smoothing (DD 75-91).
– Competitive equilibrium and prices of securities: sovereign risk assets,
competitive equilibrium and efficient distribution of risk. Arrow's securities,
complete markets, prices of securities and absence of arbitrage possibilities.
Incomplete markets and inefficient distribution of risk. Financial intermediation
and funds management: origins, growth and possible crisis of a banking
system. The additive theorem of value. Options and complete markets. (DD
145-156, 195-199, 204-210; AG 58-76).
– Behavioural finance: criticism of the Bayes, von Neumann-Morgenstern and
Savage theorems from the positive point of view. Psychological factors that
prompt investors not to update the credentials in Bayesian mode and not to
make portfolio choices on the basis of preferences about their wealth. (BT
1053-1073, 1099-1104; KR 52-65; JM 17-36, 63-94).
READING LIST
T. VAN ZANDT, Introduction to the Economics of Uncertainty and Information, 2006.
R.B. MYERSON, Probability Models for Economic Decisions, Thomson Brooks/Cole, 2005.
S. BIKHCHANDANI-S. SHARMA, Herd Behavior in Financial Markets, IMF Staff Papers, 2001.
J.P. DANTHINE-J.B. DONALDSON, Intermediate Financial Theory, Elsevier, Amsterdam, 2005.
F. ALLEN-D. GALE, Understanding Financial Crises, Oxford University Press, Oxford, 2007.
N. BARBERIS-R. THALER, A Survey of Behavioral Finance, in Constandinides et al, Handbook of the
Economics of Finance, Vol. 1, Part 2, Elsevier, Amsterdam, 1052-1090, 2003.
D. KAHNEMAN-M.K. RIEPE, Aspects of Investor Psychology, Journal of Portfolio Manager, 24(4),
1998.
J. MONTIER, Behavioural Investing. A Practitioner’s Guide To Apply Behavioural Finance, John
Wiley & Sons, 2007.
TEACHING METHOD
Lectures, assignments in class, and periodic homework. The following software will be
used during the course: Microsoft Excel and add-in Simtools.
ASSESSMENT METHOD
Written, with questions about theory and numerical exercises. A IT-related exercise in
the computer lab to tests the student's capacity to use Excel and Simtools for solving
economic-statistical-financial problems.
NOTES
The course contemplates extensive use of the economic, mathematical and statistical
concepts studied in the Economics I, General Math, and Statistics I courses for the threeyear degree programme.
It is assumed that students enrolling in this course: are familiar with the basic rules of
algebra, derivatives of polynomial and log rhythmic functions,; are able to identify the
maximum and the minimum of a function of a variable; are familiar with the concepts of
probability, conditioned probability, the Bayes rule, variance, covariance, coefficient of
correlation; are able to interpret economically the concept of the marginal rate of
substitution; and have a fairly clear idea of the concept of Walrasian equilibrium (in a
framework of general economic equilibrium). Instead, familiarity with Microsoft Excel is
not required, but may prove useful.
Several documents will be posted on the Blackboard to facilitate preparation for the
exam.
Regular class attendance and active participation in the course are definitely
recommended.
Further
information
can
be
found
on
the
lecturer's
webpage
http://www2.unicatt.it/unicattolica/docenti/index.html, or on the Faculty notice board.
at