The economics and finance of uncertainty

FINANCE AND THE ECONOMICS OF UNCERTAINTY......Page 0
Contents......Page 3
List of main symbols......Page 8
Introduction......Page 10
Part 1 Valuation by Arbitrage......Page 15
1 Financial instruments: an introduction......Page 16
1.2 Bonds......Page 17
1.3 The Spot Curve......Page 20
1.4 Stocks......Page 22
2 Derivatives Markets......Page 23
2.1 Futures Markets for Commodities and Currencies......Page 24
2.2 Futures Markets for Financial Instruments......Page 28
2.3 Options......Page 32
Exercises......Page 34
2 Arbitrage......Page 35
1.2 Securities......Page 36
1.3 Absence of Arbitrage Opportunities and Valuation......Page 39
1.4 Complete Markets......Page 43
1.5 Risk-Adjusted Probability......Page 45
2.1 Time Structure......Page 46
2.2 Instantaneous Arbitrage......Page 47
2.3 Dynamic Arbitrage......Page 48
2.4 Probabilistic Formulation: Risk-Adjusted Probability......Page 57
Exercises......Page 59
Part 2 Exchanging Risk......Page 63
1.1 Individual Demand for Savings......Page 64
1.2 Equilibrium, Optimum......Page 68
2 Introducing Uncertainty......Page 70
Bibliographical Note......Page 71
3 Investors and their information......Page 73
1 Choice Criteria......Page 74
1.1 Von Neumann Morgenstern Utility and Risk Aversion......Page 75
1.2 Standard von Neumann Morgenstern Utility Functions......Page 77
2.1 Markets and Budget Constraints......Page 78
2.2 The Demand for One Risky Security and Risk Aversion......Page 81
3 Subjective Expectations and Opportunities for Arbitrage......Page 85
4 Convergence of Expectations: Bayesian Learning......Page 88
5 The Value of Information......Page 91
Bibliographical Note......Page 95
Exercises......Page 96
4 Portfolio choice......Page 98
1 Mean–Variance Efficient Portfolios......Page 99
1.1 Portfolio Composition and Returns......Page 100
1.2 Diversification......Page 102
1.3 The Efficiency Frontier in the Absence of a Riskless Security......Page 103
1.4 Efficient Portfolios: The Case with a Risk-Free Security......Page 105
2 Portfolio Choice under the von Neumann Morgenstern Criterion......Page 107
3 Finance Paradigms: Quadratic and CARA Normal......Page 109
3.1 Hedging Portfolios......Page 111
3.2 The Demand for Risky Securities......Page 112
Exercises......Page 114
5 Optimal risk sharing and insurance......Page 118
1.1 The Model......Page 119
1.2 Insuring Individual Idiosyncratic Risks......Page 120
1.3 Optimality: Characterization......Page 122
2.1 Complete Markets......Page 126
2.3 The Role of Options......Page 128
3 Market Failures......Page 132
Bibliographical Note......Page 134
Exercises......Page 135
6 Equilibrium on the stock exchange and risk sharing......Page 139
1 The Amounts at Stake......Page 140
2 The Stock Exchange......Page 141
2.2 Investors......Page 142
2.3 Equilibrium......Page 143
3 The CAPM......Page 144
3.1 Returns......Page 145
3.2 Equilibrium Prices......Page 147
4 The General Equilibrium Model and Price Determination......Page 148
4.1 Prices of Risky Securities......Page 149
4.2 The Allocation of Risks......Page 151
4.3 Determination of the Interest Rate......Page 152
Bibliographical Note......Page 154
Exercises......Page 155
7 Trade and information......Page 160
1 Short-Term Equilibrium......Page 161
1.1 Investors......Page 162
1.2 Equilibrium......Page 163
2 Public Information and Markets......Page 166
2.1 Ex ante Complete Markets and Public Information in an Exchange Economy......Page 167
2.2 The Impact of Information: Production and Incomplete Markets......Page 170
3.1 Equilibrium with Naïve Traders......Page 174
3.2 Private Information and Rational Expectations......Page 176
3.3 Revelation of Information by Prices......Page 178
4 Information: The Normal Model......Page 180
4.1 Rational Expectations and the Aggregation of Information......Page 181
4.2 Noise and the Transmission of Information by Prices......Page 184
4.3 Insiders......Page 186
5 Formation of Expectations and Investments......Page 189
Bibliographical Note......Page 192
Exercises......Page 193
8 Intertemporal valuation......Page 198
1.1 The Economy......Page 199
1.2 The Spot Curve: A Review......Page 200
2.1 The Interest Rate Curve and Its Evolution......Page 201
2.2 The Valuation of Risky Assets......Page 203
3.1 The Interest Rate Curve......Page 206
3.2 Spot and Forward Curves: An Example......Page 209
3.3 The Dynamics of Securities Prices......Page 211
4.1 Isoelastic Utilities......Page 214
4.2 Beyond the Representative Agent......Page 216
5 Fundamental Value and Bubbles......Page 218
Bibliographical Note......Page 220
Exercises......Page 221
Part 3 The Firm......Page 223
9 Corporate finance and risk......Page 229
1.1 Financial Backers......Page 230
1.2 The Net Cash Proceeds......Page 232
2.1 The Accounting Framework......Page 233
2.2 Value of the Firm......Page 235
2.3 Stock Market Valuation......Page 237
2.5 Comments on the Leverage Effect......Page 240
3 Financial Structure......Page 242
3.1 Complete Markets......Page 243
3.2 Incomplete Markets......Page 246
Bibliographical Note......Page 248
Exercises......Page 249
10 Financing investments and limited liability......Page 251
1.1 Complete Markets......Page 252
1.2 Incomplete Markets......Page 258
1.3 Multiplicative Risk......Page 260
2 Investments, Equity Financing, and Insider Information......Page 261
3.1 The Market without Dysfunction......Page 265
3.2 Default Risk......Page 267
3.3 Equilibrium......Page 270
Bibliographical Note......Page 275
Exercises......Page 276
Index......Page 280