Asset Pricing Fundamentals

This course is part of Finance Specialization

Instructor: Lorenzo Pandolfi

Access provided by Paidy

6 modules

Gain insight into a topic and learn the fundamentals.

Intermediate level

Recommended experience

1 week to complete

at 10 hours a week

Flexible schedule

Learn at your own pace

6 modules

Gain insight into a topic and learn the fundamentals.

Intermediate level

Recommended experience

1 week to complete

at 10 hours a week

Flexible schedule

Learn at your own pace

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

Skills you'll gain

Details to know

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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 videos Total 55 minutes

Welcome to the course! 2 minutes
Introduction to Financial Markets 2 minutes
Structure of Financial Markets 3 minutes
Asset classes 2 minutes
Presence or absence of intermediaries 2 minutes
Functions of financial markets 2 minutes
Intemporal reallocation of resources 1 minute
Efficient allocation of investment 2 minutes
Risk pooling and risk sharing 1 minute
Information transmission 2 minutes
Introduction to consumption and investment in autarky 1 minute
Assumptions 3 minutes
Robinson Crusoe's problem 1 minute
The model solution 3 minutes
Heterogeneous preferences 2 minutes
Heterogeneous endowments 1 minute
Heterogeneous technologies 2 minutes
Assumptions 2 minutes
The problem of households 2 minutes
The model solution 2 minutes
The equilibrium interest rate 3 minutes
Consumption and investment with financial markets and production 2 minutes
The problem of households 1 minute
The optimal saving of households 2 minutes
The problem of firms 1 minute
The equilibrium of the model 2 minutes
Comparison with the autarky case 2 minutes
Fisher separation theorem 2 minutes
Imperfect capital markets 2 minutes
Transaction costs 2 minutes
Borrowing constraints 1 minute

4 readings Total 19 minutes

Functions of financial markets 5 minutes
Consumption and investment in autarky 3 minutes
Consumption and investment with financial markets 10 minutes
To sum up 1 minute

3 assignments Total 45 minutes

Functions of financial markets 30 minutes
Consumption and investment in autarky 10 minutes
Consumption and investment with financial markets 5 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 videos Total 60 minutes

Introduction 3 minutes
What is a lottery? 2 minutes
Risk aversion 1 minute
Compound lotteries 3 minutes
Expected utility 2 minutes
Expected utility: an example 2 minutes
Axioms 2 minutes
Attitude towards risk 2 minutes
Risk aversion 2 minutes
Risk neutrality 2 minutes
Risk loving 1 minute
Measuring risk aversion 2 minutes
Example 8 minutes
Hara utility 2 minutes
Markowitz risk premium 4 minutes
Comparing risks 2 minutes
First Order Stochastic Dominance 2 minutes
FOSD with discrete distributions 4 minutes
Second Order Stochastic Dominance 9 minutes
Mean-variance criterion 2 minutes
Expected utility and mean-variance criterion 4 minutes

4 readings Total 31 minutes

Expected utility 10 minutes
Attitudes towards risk 10 minutes
Comparing risks 10 minutes
To sum up 1 minute

3 assignments Total 50 minutes

Choice under uncertainty 30 minutes
Expected utility 10 minutes
Attitudes towards risk 10 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 videos Total 59 minutes

The market for contingent claims 6 minutes
Law of one price 3 minutes
Arbitrage 9 minutes
How to construct an arbitrage portfolio 6 minutes
LOP and Arbitrage 5 minutes
No arbitrage and the price of Arrow securities 2 minutes
No arbitrage and optimal portfolios 3 minutes
State prices 4 minutes
Determining state prices 3 minutes
Risk-free assets 3 minutes
Risk-neutral probabilties 2 minutes
Determining asset prices 3 minutes
Pricing a risky asset with state prices 6 minutes
Example 6 minutes

4 readings Total 40 minutes

Law of one price and arbitrage 10 minutes
Complete markets and state prices 10 minutes
From state prices to asset prices 10 minutes
To sum up 10 minutes

3 assignments Total 50 minutes

Contingent claim markets 30 minutes
Law of one price and arbitrage 15 minutes
Complete markets and state prices 5 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 videos Total 50 minutes

Introduction to Portfolio choices 2 minutes
Hypotheses 3 minutes
The investor's problem 2 minutes
The demand for stocks 2 minutes
An example with log utility 7 minutes
What if the investor is risk-neutral? 3 minutes
The partecipation principle 2 minutes
Example 7 minutes
An example with power utility 8 minutes
The partecipation puzzle 3 minutes
Risk aversion and the demand for stocks 2 minutes
Wealth and the demand for stocks 3 minutes
Expected return, risk and the demand for stocks (part 1) 2 minutes
Expected return, risk and the demand for stocks (part 2) 2 minutes
Special case of increasing absolute risk aversion 3 minutes

4 readings Total 40 minutes

The canonical portfolio problem 10 minutes
The participation principle 10 minutes
Preferences, stock characteristics, and stock demand 10 minutes
To sum up 10 minutes

3 assignments Total 40 minutes

Canonical portfolio problem 30 minutes
The canonical portfolio problem 5 minutes
The participation principle 5 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 videos Total 72 minutes

Motivation 4 minutes
Properties of expectation, variance and covariance operators 6 minutes
Indifferent curves with quadratic utility 7 minutes
Indifference curves with CARA and normally distributed payoffs 3 minutes
Two risky assets 4 minutes
Case 1: perfectly correlated returns 6 minutes
Case 2: inversely correlated returns 5 minutes
The general case 6 minutes
Driving the shape of the frontier 2 minutes
The frontier with N risky assets 5 minutes
The frontier with a riskless asset 5 minutes
Optimal portfolios with only risky assets 8 minutes
Optimal portfolios with a riskless asset 3 minutes
Implications 3 minutes
Sharpe ratio 2 minutes
The market portfolio 3 minutes

4 readings Total 21 minutes

Mean-variance preferences 5 minutes
Efficient frontier 10 minutes
Mean-variance portfolio choice 5 minutes
To sum up 1 minute

4 assignments Total 65 minutes

Mean-Variance analysis 30 minutes
Mean-variance preferences 10 minutes
Efficient frontier 15 minutes
Mean-variance portfolio choice 10 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.