The topics and approaches combine macroeconomics and finance, with an emphasis on developing and testing theories which involve linkages between financial markets and the macro economy.
This course is based on three ideas:
1 ) First, returns are not random walks but are predictable over business cycle and longer horizons. Thus, we need macroeconomic models that generate predictability – through time-varying risk aversion for example – and appropriate empirical methods to estimate them.
2 ) Second, all financial assets can be understood using a stochastic discount factor m and a description of their payoff X. The price P of a financial asset is then simply =E(MX). Macroeconomic model give us ideas about the form of the stochastic discount factor M. GMM estimators give us a natural framework to test these ideas.
3 ) Third, time varying risk premium dramatically changes portfolio theory, leading to new computing issues and solutions to old Merton problems.
We will cover the modern stochastic discount factor approach to asset pricing theory, with applications to stocks, bonds and currencies. We will go back and forth between macroeconomic and financial theories and empirical tests of these theories.
The recommended textbook for this class is:
John Cochrane. (2005). Asset Pricing. Princeton University Press (I will abbreviate it as AP below).
Slides & Class Material
You will find slides and other class material in the password protected section of this web site.
Problem set # 1 (file – due date 16/11 3PM)