EC4204 (Provisional may change)
Financial Economic Theory
LECTURER:
Dr Gary Shea
Candlemas (Second) Semester 2015/16
CREDITS: 30
LECTURES/SEMINARS:
SEMINARS:
26 lectures, 3 lectures per week, dates TBA Problem-solving spreadsheet based
seminar sessions embedded in lecture
schedule but held in a computer
laboratory (TBA)
EXAMINATION:
1 three-hour paper
CONTINUOUS ASSESSMENT:
1 class test, date TBA
1 computer spreadsheet-based exercise
to be held in a computer lab, date TBA
FINAL GRADE:
Examination: 70% weight
Class Test: 15% weight
Spreadsheet exercise: 15% weight
SUPPLEMENTARY INFORMATION:
EC4204 is the final required course for
the degree in Financial Economics.
BRIEF MODULE OUTLINE
This module follows EC4501 and EC4502 and completes the Honours degree in Financial
Economics. EC4204 includes an introduction to the theoretical development of asset
pricing models and extensive coverage of the theoretical foundations of option pricing.
Whereas in EC4501 and EC4502 the student solved small binomial option pricing
problems, in EC4204 the foundations of the binomial approach and its extensions to
multinomial option pricing and, ultimately, the derivation of the Black-Scholes formula
are studied. EC4501 and EC4502 emphasised the solution of small case-study like
financial problems via the application of the standard CAPM pricing model. In EC4204
we derive the CAPM model from its foundations and study its theory in detail. The
theoretical and empirical implications of the CAPM and other pricing models for
evaluating portfolio performance are also studied in depth.
Learning Outcomes
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Returning to the economic foundations of the concepts of return and risk, we will
formally derive the basic elements of portfolio theory.
You will see how portfolio theory can lead to variations of the standard valuation
model for investments – the CAPM.
You will learn how to derive alternative asset pricing models to the CAPM, and how
the latter differs from them in its theoretical assumptions and predictions.
We will overview some recent theoretical challenges to standard asset pricing
models that derive from relaxing the standard assumptions about market efficiency.
You will see how separate is the theory of option pricing from standard risk-return
pricing models, and how different are the theoretical foundations of option pricing.
We will formalise the so-called “no-arbitrage” condition and show how it constitutes
the basic theoretical foundation of all option pricing models.
You will learn how to use the “no-arbitrage” condition to develop richer and more
detailed option pricing models.
You will learn how a number of the basic theoretical concepts that will be covered in
this course can be implemented in computer spreadsheet models.
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You will expand the set of transferable skills you have already developed in your
financial economics studies to being able to implement theory in programming
languages and to conduct basic empirical work in portfolio analysis and financial
econometrics.
MAIN READING
The textbooks for this module are:
Bodie Z., Kane A., and A. Marcus (2011) Investments and Portfolio Management, McGrawHill (9th ed.)
Hull J.C. (2005) Options, Futures, and Other Derivatives, Prentice Hall (6th ed.)