Asset Pricing Fundamentals

This course is part of Finance Specialization

Instructor: Lorenzo Pandolfi

What you'll learn

Understand the principles underlying investors' portfolio choices and the criteria that determine the prices of financial instruments
Understand the main functions performed by the financial markets
Analyzing how the introduction of the financial markets influences the saving choices of households
Analyzing how the introduction of the financial markets influences the investment choices of businesses in an economy without uncertainty

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Assessments

20 assignments

Taught in English

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This course is part of the Finance Specialization

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There are 6 modules in this course

The course Asset Pricing I will provide students with the main theoretical and analytical tools to study and understand the economics of financial markets and portfolio choices. After learning the different structure that financial markets can take and the key functions that these perform, learners will analyze how financial markets affect saving and investment decisions in an economy with no uncertainty.

Then, learners will be introduced to expected utility theory, which will provide them with the key analytical tools to study choices under uncertainty. These tools will then be used to model and analyze portfolio choices: first, learners will study the so-called canonical portfolio problem, that is, the problem of an investor who has to choose how to allocate their wealth between a safe and a risky asset; then, they will study portfolio choices that involve multiple risky assets. The analysis of portfolio choices will allow learners to characterize and determine investors’ optimal demand for risky assets, which will lay the foundation for the analysis of the Capital Asset Pricing Model, a milestone for asset pricing and financial economics. The analysis of the CAPM will finally teach learners how to characterize equilibrium returns and asset prices in financial markets, also understanding the key forces that govern these key variables.

By the end of this week, you will learn the various structures financial markets can adopt and comprehend their primary functions. You'll also be able to assess how the establishment of financial markets influences households' choices regarding saving and borrowing, along with companies' decisions regarding investment, all within an economy devoid of uncertainty.

What's included

31 videos4 readings3 assignments

31 videosTotal 55 minutes

Welcome to the course!1 minutePreview module
Introduction to Financial Markets1 minute
Structure of Financial Markets2 minutes
Asset classes1 minute
Presence or absence of intermediaries1 minute
Functions of financial markets1 minute
Intemporal reallocation of resources1 minute
Efficient allocation of investment1 minute
Risk pooling and risk sharing1 minute
Information transmission1 minute
Introduction to consumption and investment in autarky0 minutes
Assumptions2 minutes
Robinson Crusoe's problem1 minute
The model solution3 minutes
Heterogeneous preferences1 minute
Heterogeneous endowments1 minute
Heterogeneous technologies1 minute
Assumptions1 minute
The problem of households1 minute
The model solution1 minute
The equilibrium interest rate3 minutes
Consumption and investment with financial markets and production1 minute
The problem of households1 minute
The optimal saving of households1 minute
The problem of firms1 minute
The equilibrium of the model2 minutes
Comparison with the autarky case1 minute
Fisher separation theorem1 minute
Imperfect capital markets1 minute
Transaction costs1 minute
Borrowing constraints1 minute

4 readingsTotal 19 minutes

Functions of financial markets5 minutes
Consumption and investment in autarky3 minutes
Consumption and investment with financial markets10 minutes
To sum up1 minute

3 assignmentsTotal 45 minutes

Functions of financial markets30 minutes
Consumption and investment in autarky10 minutes
Consumption and investment with financial markets5 minutes

This week you will learn the theoretical principles that underlie individual choices under uncertainty, that is, in the presence of risk, in light of expected utility theory. Additionally, you will examine how to characterize agents' attitudes towards risk and the primary criteria for comparing risky prospects. These criteria include first- and second-order stochastic dominance, as well as the mean-variance criterion.

What's included

21 videos4 readings3 assignments

21 videosTotal 59 minutes

Introduction3 minutesPreview module
What is a lottery?2 minutes
Risk aversion1 minute
Compound lotteries3 minutes
Expected utility1 minute
Expected utility: an example2 minutes
Axioms2 minutes
Attitude towards risk1 minute
Risk aversion1 minute
Risk neutrality1 minute
Risk loving0 minutes
Measuring risk aversion1 minute
Example7 minutes
Hara utility1 minute
Markowitz risk premium3 minutes
Comparing risks1 minute
First Order Stochastic Dominance1 minute
FOSD with discrete distributions4 minutes
Second Order Stochastic Dominance8 minutes
Mean-variance criterion2 minutes
Expected utility and mean-variance criterion4 minutes

4 readingsTotal 31 minutes

Expected utility10 minutes
Attitudes towards risk10 minutes
Comparing risks10 minutes
To sum up1 minute

3 assignmentsTotal 50 minutes

Choice under uncertainty30 minutes
Expected utility10 minutes
Attitudes towards risk10 minutes

By the end of this week you will understand how to analyze contingent claim markets and the risk neutral evaluation.

What's included

14 videos4 readings3 assignments

14 videosTotal 59 minutes

The market for contingent claims5 minutesPreview module
Law of one price3 minutes
Arbitrage9 minutes
How to construct an arbitrage portfolio6 minutes
LOP and Arbitrage4 minutes
No arbitrage and the price of Arrow securities1 minute
No arbitrage and optimal portfolios2 minutes
State prices3 minutes
Determining state prices3 minutes
Risk-free assets2 minutes
Risk-neutral probabilties1 minute
Determining asset prices3 minutes
Pricing a risky asset with state prices5 minutes
Example6 minutes

4 readingsTotal 40 minutes

Law of one price and arbitrage10 minutes
Complete markets and state prices10 minutes
From state prices to asset prices10 minutes
To sum up10 minutes

3 assignmentsTotal 50 minutes

Contingent claim markets30 minutes
Law of one price and arbitrage15 minutes
Complete markets and state prices5 minutes

By the end of this week you will learn the principles underlying investors' portfolio choice and to analyze, in particular, how stock market participation depends on individual preferences and stocks' fundamentals (expected return and riskiness).

What's included

15 videos4 readings3 assignments

15 videosTotal 50 minutes

Introduction to Portfolio choices1 minutePreview module
Hypotheses3 minutes
The investor's problem2 minutes
The demand for stocks1 minute
An example with log utility6 minutes
What if the investor is risk-neutral?3 minutes
The partecipation principle2 minutes
Example6 minutes
An example with power utility7 minutes
The partecipation puzzle3 minutes
Risk aversion and the demand for stocks2 minutes
Wealth and the demand for stocks2 minutes
Expected return, risk and the demand for stocks (part 1)1 minute
Expected return, risk and the demand for stocks (part 2)2 minutes
Special case of increasing absolute risk aversion2 minutes

4 readingsTotal 40 minutes

The canonical portfolio problem10 minutes
The participation principle10 minutes
Preferences, stock characteristics, and stock demand10 minutes
To sum up10 minutes

3 assignmentsTotal 40 minutes

Canonical portfolio problem30 minutes
The canonical portfolio problem5 minutes
The participation principle5 minutes

By the end of this week you will be able to identify the set of efficient portfolios in an economy with many risky assets and to analyze, in this economy, the portfolio choices of investors with mean-variance preferences, so as to characterize stocks' aggregate demand.

What's included

16 videos4 readings4 assignments

16 videosTotal 72 minutes

Motivation3 minutesPreview module
Properties of expectation, variance and covariance operators5 minutes
Indifferent curves with quadratic utility6 minutes
Indifference curves with CARA and normally distributed payoffs3 minutes
Two risky assets4 minutes
Case 1: perfectly correlated returns6 minutes
Case 2: inversely correlated returns5 minutes
The general case6 minutes
Driving the shape of the frontier2 minutes
The frontier with N risky assets4 minutes
The frontier with a riskless asset4 minutes
Optimal portfolios with only risky assets7 minutes
Optimal portfolios with a riskless asset3 minutes
Implications3 minutes
Sharpe ratio2 minutes
The market portfolio2 minutes

4 readingsTotal 21 minutes

Mean-variance preferences5 minutes
Efficient frontier10 minutes
Mean-variance portfolio choice5 minutes
To sum up1 minute

4 assignmentsTotal 65 minutes

Mean-Variance analysis 30 minutes
Mean-variance preferences10 minutes
Efficient frontier15 minutes
Mean-variance portfolio choice10 minutes

By the end of this week, you will learn the concept of equilibrium in financial markets. You'll apply this understanding to an economy featuring numerous risky assets and a riskless asset, all within a framework of risk-averse investors with mean-variance preferences. Additionally, you'll gain the ability to calculate equilibrium prices and expected excess returns. Furthermore, you'll recognize that these values are contingent upon the covariance risk of assets, which is quantified by asset betas.