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Lecture Slides Overview
Lecture Slides Overview
Course Overview
Martin Haugh
Garud Iyengar
Continuous time models Discrete time models vs Continuous time models Pros: All important concepts with less sophisticated mathematics Cons: No closed form solutions ... have to resort to numerical calculations. Focus of this course: Discrete time multi-period models Caveat: Some continuous time concepts covered, e.g. the Black-Scholes formula.
Central problems of FE
Security pricing Primary securities: stocks and bonds ... nancial economics Derivative securities: forwards, swaps, futures, options. Portfolio selection: choose a trading strategy to maximize the utility of consumption and nal wealth. Intimately related to security pricing Single-period models: Markowitz portfolio selection Real options Risk management: understand the risks inherent in a portfolio Tail risk: probability of large losses Value-at-risk and conditional value-at-risk Starting to become important for portfolio selection as well. Led to interesting applied math / operations research problems.
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Interpretation c0 = cost of purchasing the cash ow (c1 , . . . , cT ) Suppose ck 0 for all k 1. Then cost c0 0 Suppose ck 0 for all k 1 and cl > 0 for some l . Then cost c0 > 0 Why? The cash ow has a seller who receives c0 and pays out ck for k 1 Since ck 0 for all k 1 the seller can increase the price c0 The seller can continue to increase the price until c0 = 0 Assumptions Price information is available to all buyers and sellers Enough buyers and sellers
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Example. What is the value of a contract that pays A dollars in 1 year. Suppose one is able to borrow or lend unlimited amounts at r per year. Buy contract at price p and borrow A/(1 + r ) at interest rate r Cashow now A p + 1 + r Cashow in 1 year AA=0
A 1+r .
Sell contract at price p and lend A/(1 + r ) at interest rate r Same arguments imply that p
A 1+r