Introductory description

Asset Pricing and Risk is a core module for all students in the first (autumn) term of the MSc in Mathematical Finance. The objective of this module is to provide a rigorous, in-depth introduction to the theoretical foundations and empirical applications of Asset Pricing. It focuses primarily on the investor's perspective and analyses individual's consumption and portfolio choice and their implications for equilibrium asset prices. In addition, contingent claims valuation techniques based on the absence of arbitrage are presented.

Module web page

Module aims

Outline syllabus

This is an indicative module outline only to give an indication of the sort of topics that may be covered. Actual sessions held may differ.

Introduction to Markets and Instruments. Net Present Value
Fixed Income securities markets
Valuation of discount and coupon bonds
Spot, forward rates, yield-to-maturity
Interest rate risk
Corporate bonds, Pricing of green bonds
Modelling Investor Preferences in the Presence of Uncertainty
The "Axioms of Choice"
Utility Functions and Risk Premium
Building a Theory of Portfolio Allocation on the Basis of Utility Framework
Foundations from Utility Theory
Diversification; Efficient Portfolios; Optimal Asset Allocation
Combining "Portfolio Theory" with Market Equilibrium
The Capital Asset Pricing Model (CAPM)
Factor Models: Empirical Evaluation
Extending the Basic CAPM: Multi-Factor Models
Zero-Beta CAPM
Conditional CAPM
Arbitrage Pricing Theory
Basic Model of Asset Pricing under Uncertainty without Preferences
States, Pay-Offs, Prices and Arbitrage
Arrow-Debreu Prices, Completeness
Risk-Neutral Pricing, the Stochastic Discount Factor
Multi-Period Models: Dynamic Completeness, Martingales
Contingent Claims: Arbitrage, Pricing, and Hedging
Dynamic Optimality and Equilibrium
Efficient Markets. Introduction to Behavioural Finance

Learning outcomes

By the end of the module, students should be able to:

• Define and explain, intuitively and formally, the fundamental trade-off between risk and return, and how this can be modelled and quantified.
• Demonstrate full understanding of how individuals make decisions in the presence of uncertainty, and how these affect asset prices and returns in equilibrium
• Demonstrate full understanding of how the principle of “absence of arbitrage” is used for valuation and hedging of “contingent claims” in both static and dynamic models
• Use a variety of quantitative and statistical tools to analyse data and implement/assess quantitative solutions to problems in Asset Pricing

Indicative reading list

[BMM] Brealey, R.A., S.C. Myers, and A.J. Marcus:
"Fundamentals of Corporate Finance" (10th ed., 2020) McGraw-Hill;
[BD] Berk, J.B., and P.M. DeMarzo:
"Corporate Finance" (5th ed., 2019) Pearson;
[TKM] Titman, S., A.J. Keown andJ.D. Martin:
"Financial management: Principles and Applications" (13th ed., 2018) Pearson;
[DD] Danthine, J.-P. and J.B. Donaldson:
"Intermediate Financial Theory" Prentice-Hall
[D] Duffie, D.: "Dynamic Asset Pricing Theory"; Princeton University Press
[CWS] Copeland, T., J.F. Weston, and K. Shastri: "Financial Theory and Corporate Policy", Pearson

Research element

The students will work on group project which involves research activity, summary of literature review and creative solutions, data work and coding

Interdisciplinary

The module naturally spans Finance, Economics, Mathematics and Statistics aspects

International

The case studies cover international markets and practices.

Subject specific skills

Design and implement empirical methodology to a) estimate the parameters of, and b) assess the validity of, a variety of asset pricing models.
Design and implement optimal strategies for asset allocation or risk management; devise and apply measures of performance of such strategies.

Transferable skills

Demonstrate academic writing skills.
Critically evaluate empirical research.