Rutgers Business School--Newark and New Brunswick
Finance 26:390:571:01 (or MQF 22:839:571:30)
Survey of Financial Theory I
Spring 2004 (Revised 2/4/04)
Professor Yangru Wu
Phone: 973-353-1146
Email: yangruwu@andromeda.rutgers.edu
Homepage: http://andromeda.rutgers.edu/~yangruwu
Class Hrs: W 2:30-5:20
Classroom: Eng 303
Office Hrs: by appointment
Course Description
This course is the first of the two-course sequence in financial theory for Ph.D. students.
It covers basic concepts and tools in asset pricing and portfolio theory and builds a foundation
for the study of higher-level courses in corporate finance and investment theory.
To do successfully in this course, students should know investments at the level of a
textbook such as Bodie, Kane and Marcus and microeconomics at the level of Varian. The
required mathematical prerequisites are matrix algebra, calculus and basic probability.
Main References
1. Huang, Chi-fu and Robert Litzenberger, 1988, Foundations for Financial Economics,
Prentice-Hall, ISBN 0-13-500653-8.
2. Copeland, Thomas E. and J. Fred Weston, 1992, Financial Theory and Corporate Policy,
3rd ed., Addison-Wesley Publishing Company.
3. Cochrane, John, 2001, Asset Pricing, Princeton University Press, ISBN 0691-074-984.
Other Useful References
4. Ingersoll, Jonathan, 1987, Theory of Financial Decision Marking, Rowman & Littlefield.
5. Debreu, G., 1959, Theory of Value, Yale University Press.
6. Campbell, John Y., Andrew W. Lo and A. Craig MacKinlay, 1997, The Econometrics of
Financial Markets, Princeton University Press.
Grading Policy
For Ph.D. students
1. There will be an in-class final examination taken at the end of the semester, which
counts for 55% of your course grade.
2. Each student will have to submit a term paper by May 6. The term paper can be a
short literature survey of a topic that is of interest to you but is not covered in class,
an application of some techniques discussed in the course to a specific area, or an
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empirical study using current data. After choosing a paper topic, each student should
see me to discuss the feasibility of the project. The term paper will count for 30% of
your grade.
3. Class participation and presentation will count for the remaining 15% of your grade. I
expect students to come to class and actively participate in the discussion. Each
student will make two presentations. The first presentation is on a paper on the
reading list. The second presentation is based on the student’s own research paper.
For MQF students
1. There will be an in-class final examination taken at the end of the semester, which
counts for 45% of your course grade.
2. Computer-related assignments will count for 50%.
3. Active class participation will count for the remaining 5% of your grade.
Topics Covered
I.
Expected Utility Theory and Portfolio Decision Problem
Huang-Litzernberger Chapter 1
Copeland-Weston Chapter 4
Pratt, John W., 1964, Risk aversion in the small and in the large, Econometrica 32, 122-136.
II.
Generalized Risk and Asset Pricing
Huang-Litzernberger Chapter 2
Copeland-Weston Chapter 4
Rothschild, M. and J.E Stiglitz, 1970, Increasing risk I: A definition, Journal of Economic Theory 2,
225-43.
III.
The Mean-Variance Frontier
Huang-Litzernberger Chapter 3
Copeland-Weston Chapter 6
Cochrane Chapter 5
Markowitz, Harry, 1952, Portfolio selection, Journal of Finance 7, 77-91.
Merton, Robert C., 1972, An analytical derivation of the efficient portfolio frontier, Journal of
Financial and Quantitative Analysis 7, 1851-1872.
IV.
Market Equilibrium and the CAPM
Huang-Litzernberger Chapter 4
Copeland-Weston Chapter 7
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Black, Fischer, 1972, Capital market equilibrium with restricted borrowing, Journal of Business
45, 444-455.
Fama, Eugene, 1971, Risk, return and equilibrium, Journal of Political Economy, 30-55.
Lintner, John, 1965, The valuation of risk assets and the selection of risky investments in stock
portfolios and capital budgets, Review of Economics and Statistics 47, 13-37.
Mossin, Jan, 1966, Equilibrium in a capital asset market, Econometrica 34, 768-783.
Sharpe, William F., 1964, Capital asset prices: A theory of market equilibrium under conditions
of risk, Journal of Finance 19, 425-442.
V.
Linear Valuation and Factor Models
Huang-Litzernberger Chapter 4
Copeland-Weston Chapter 7
Cochrane Chapter 9
* Fama, Eugene and Kenneth R. French, 1993, Common risk factors in the returns on stocks and
bonds, Journal of Financial Economics 33, 3-56.
Fama, Eugene and Kenneth R. French, 1996, Multifactor explanations of asset-pricing
anomalies, Journal of Finance 51, 55-84.
Ross, Stephen A., 1976, The arbitrage theory of capital-asset pricing, Journal of Economic
Theory 13, 341-360.
Shanken, Jay, 1982, The arbitrage pricing theory: Is it testable? Journal of Finance 37, 11291140.
VI.
State Preference Theory and Equilibrium under Complete Markets
Huang-Litzernberger Chapter 5
Copeland-Weston Chapter 5
Arrow, K., 1964, The role of securities in the optimal allocation of risk bearing, Review of
Economic Studies 31, 91-96.
Breeden, D. and R. Litzenberger, 1978, Prices of state contingent claims implicit in option prices,
Journal of Business 51, 621-52.
VII.
Consumption-Based Asset Pricing Model
Cochrane Chapter 1
Cecchetti, Stephen, P.S. Lam and N. Mark, 1994, Testing volatility restrictions on intertemporal
marginal rates of substitution implied by Euler equations and asset returns, Journal of
Finance 49, 123-152.
Hansen, Lars P. and Kenneth Singleton, 1982, Generalized instrumental variables estimation of
nonlinear rational expectations models, Econometrica 50, 1269-1288.
Hansen, Lars P. and Kenneth Singleton, 1983, Stochastic consumption, risk aversion and the
temporal behavior of asset returns, Journal of Political Economy 91, 249-268.
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* Hansen, Lars P. and Ravi Jagannathan, 1991, Implications of security market data for models of
dynamic economies, Journal of Political Economy 99, 225-262.
Hansen, Lars P. and Ravi Jagannathan, 1992, Assessing specification errors in stochastic discount
factor models, Journal of Finance 52, 557-590.
Hansen, Lars P. and Scott Richard, 1987, The role of conditioning information in deducing testable
restrictions implied by dynamic asset pricing models, Econometrica 55, 587-614.
Lucas, Robert E. Jr., 1978, Asset prices in an exchange economy, Econometrica 46, 1429-45.
VIII.
Empirical Tests of Asset Pricing Models
Huang-Litzernberger Chapter 10
Copeland-Weston Chapter 7
Cochrane Chapters 12, 15
Banz, R.W., 1981, The relationship between return and market value of common stocks, Journal
of Financial Economics 9, 3-18.
Blume, M and I. Friend, 1973, A new look at the capital asset pricing model, Journal of Finance
28, 19-33.
* Chen, N.F., R. Roll and S. Ross, 1986, Economic forces and the stock market, Journal of
Business 59, 383-403.
Fama, Eugene and J. MacBeth, 1973, Risk, return, and equilibrium: Empirical tests, Journal of
Political Economy 81, 607-636.
Fama, Eugene and Kenneth R. French, 1992, The cross-section of expected stock returns,
Journal of Finance 47, 427-65.
Gibbons, M, 1982, Multivariate tests of financial models: A new approach, Journal of Financial
Economics 14, 3-27.
Gibbons, M., S. Ross and J. Shanken, 1989, A test of the efficiency of a given portfolio,
Econometrica 57, 1121-1152.
* Keim, D. B., 1983, Size-related anomalies and stock return seasonality, Journal of Financial
Economics 12, 13-32.
Roll, Richard, 1977, A critique of the asset pricing theory’s tests; part I: on past and potential
testability of the theory,” Journal of Financial Economics, 129-176.
Shanken, Jay, 1985, Multivariate tests of the zero-beta CAPM, Journal of Financial Economics
14, 327-348.
IX.
Market Efficiency and Market Anomalies
Balvers, Ronald J., Yangru Wu, and Erik Gilliland, 2000, Mean reversion across national stock
markets and parametric contrarian investment strategies, Journal of Finance 55, 745-772.
Balvers, Ronald J. and Yangru Wu, 2003, Momentum and mean reversion across national equity
markets, mimeo.
Barberis, Nicholas, Andrei Shleifer, and Robert Vishny, 1998, A model of investor sentiment,
Journal of Financial Economics 49, 307-343.
Daniel, Kent, David Hirshleifer, and Avanidhar Subrahmanyam, 1998, Investor psychology and
security market under- and over-reactions, Journal of Finance 53, 1839-1886.
DeBondt, Werner, and Richard Thaler, 1985, Does the stock market overreact? Journal of
Finance 40, 793-805.
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* Fama, Eugene, and Kenneth French, 1988, Permanent and temporary components of stock
prices, Journal of Political Economy 96, 246-273.
Hirshleifer, David, 2001, Investor psychology and asset pricing, Journal of Finance 56, 15331597.
Hong, Harrison, and Jeremy C. Stein, 1999, A unified theory of underreaction, momentum
trading, and overreaction in asset markets, Journal of Finance 54, 2143-2184.
Jegadeesh, Narasimhan, and Sheridan Titman, 2001, Profitability of momentum strategies: an
evaluation of alternative explanations, Journal of Finance 56, 699-720.
Jegadeesh, Narasimhan, and Sheridan Titman, 1993, Returns to buying winners and selling
losers: Implications for stock market efficiency, Journal of Finance 48, 65-91.
* Lo, Andrew W., and A. Craig MacKinlay, 1988, Stock market prices do not follow random
walks: Evidence from a simple specification test, Review of Financial Studies 1, 41-66.
Poterba, James, and Lawrence Summers, 1988, Mean reversion in stock prices: Evidence and
implications, Journal of Financial Economics 22, 27-59.
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