Microfoundations of Financial Economics: An Introduction to General Equilibrium Asset Pricing

Microfoundations of Financial Economics: An Introduction to General Equilibrium Asset Pricing

by Yvan Lengwiler
     
 

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ISBN-10: 0691113157

ISBN-13: 9780691113159

Pub. Date: 03/22/2004

Publisher: Princeton University Press

This textbook takes the reader from the level of microeconomics principles through to modern asset pricing theory. Yvan Lengwiler elegantly links together issues that have in the past been the territory of general economic theorists on the one hand, and financial economists on the other.

In a sequence of carefully explained steps, the reader learns how the first

Overview

This textbook takes the reader from the level of microeconomics principles through to modern asset pricing theory. Yvan Lengwiler elegantly links together issues that have in the past been the territory of general economic theorists on the one hand, and financial economists on the other.

In a sequence of carefully explained steps, the reader learns how the first welfare theorem is used in asset pricing theory. The book then moves on to explore Radner economies and von Neumann-Morgenstern decision theory, and this section culminates in Wilson's mutuality principle and the consumption-based CAPM. This is then put into a dynamic setting, and term structure models are introduced. The empirical shortcomings of the standard asset pricing models are extensively discussed, as is research from the last twenty years aimed at bringing theory in line with reality. The reader is brought up to date on the latest areas of concern, such as habit formation, the consequences of heterogeneity, demographic effects, changing tax regimes, market frictions, and the implications of prospect theory for asset pricing.

Aimed at masters or Ph.D. students specializing in financial economics, the book can also be used as a supplementary text for students of macroeconomics at this advanced level and will be of interest to finance professionals with a background in economics and mathematics. It includes problems (with solutions), and an accompanying website provides supporting material for lecturers.

Product Details

ISBN-13:
9780691113159
Publisher:
Princeton University Press
Publication date:
03/22/2004
Series:
Princeton Series in Finance Series
Pages:
304
Product dimensions:
6.10(w) x 9.30(h) x 1.00(d)

Table of Contents

List of boxes xi
Preface xiii
1 Introduction 1
1.1 What Finance theory is about 1
1.2 Some history of thought 2
1.3 The importance of the puzzles 7
1.4 Outline of the book 9
2 Contingent claim economy 10
2.1 The commodity space 10
2.2 Preferences and ordinal utility 14
2.3 Maximization 16
2.4 General equilibrium 23
2.5 The representative agent 32
Notes on the literature 35
Problems 35
3 Asset economy 37
3.1 Financial assets 37
3.2 Pricing by redundancy 41
3.3 Radner economies 46
3.4 Complete markets (and uniqueness of Arrow prices) 53
3.5 Complications arising from market incompleteness 60
Notes on the literature 65
Problems 65
4 Risky decisions 68
4.1 Bernoulli's St.Petersburg paradox 69
4.2 Using more structure: probabilities and lotteries 71
4.3 The von Neumann -Morgenstern representation 75
4.4 Measures of risk preference 81
4.5 Assumptions and evidence 86
4.6 Often used specifications 91
Notes on the literature 99
Problems 99
5 Staticfinance economy 102
5.1 An economy with von Neumann -Morgenstern agents 102
5.2 Efficient risk-sharing 107
5.3 A representative NM agent 112
5.4 Who holds what kind of portfolio? 121
5.5 The stochastic discount factor 126
5.6 The equilibrium price of time 130
5.7 The equilibrium price of risk 132
5.8 Some important special cases 134
Notes on the literature 138
Problems 138
6 Dynamicfinance economy 141
6.1 A static dynamic model 141
6.2 Dynamic trading 149
6.3 Models of the real interest rate 162
6.4 Portfolio selection 168
Notes on the literature 170
Problems 170
7 Empirics and the puzzles 172
7.1 Collecting the right data 172
7.2 The equity premium puzzle 176
7.3 Alternative interpretations of the data 184
7.4 Excessive volatility 192
7.5 Anomalies 197
Notes on the literature 198
8 Adapting the theory 199
8.1 Assumptions of the mainstream model 199
8.2 Non-standard preferences 201
8.3 Heterogeneity 214
8.4 Efficiency failure 225
Notes on the literature 238
9 Epilog 239
9.1 A mystery 240
9.2 A challenge 241
9.3 The party's over 242
Appendix A Symbols and notation 245
Appendix B Solutions to the problem sets 247
Bibliography 269
Index 285

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