ECO5025F - Asset Pricing

Course Information

This is an advanced course in finance, aimed at students in economics and/or finance with some background in calculus and mathematical statistics, and previous coursework in finance at the level of Financial Economics I. Any student in the coursework masters and/or doctoral programmes in the economics department, who has taken a solid semester course in finance before, will meet these criteria. (Students from other faculties: consult the instructors.) The course will introduce the modern theory of arbitrage-free asset pricing, mostly in the continuous-time framework, and present applications to the pricing of derivatives and interest rate modelling.

Syllabus

Risk neutral valuation in discrete time; asset pricing with stochastic discount factor; stochastic integrals; Itos formula; partial differential equations; Feynman-Kac representation theorem; Black-Scholes-Merton arbitrage argument; derivation of Black-Scholes equation; the Radon-Nikodym derivative; Girsanovs theorem; change of measure; derivation of Black-Scholes formula; introduction to incomplete markets; bonds and interest rates; the term structure equation; affine term structures and standard models; econometrics: maximum likelihood and generalized method of moments; practical applications and extensions of the Black-Scholes model; delta hedging; volatility smiles; forwards and futures; other topics.

Main textbooks

Hull, John. 2005. Options, Futures and Other Derivatives, nth edition. New Jersey: Prentice-Hall. Bjork, Tomas. 2004. Arbitrage Theory in Continuous Time, second edition. Oxford: Oxford University Press. [The first edition, 1998, is also suitable]