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

by Lengwiler, Yvan

• ISBN13: 9781400829576
• ISBN10: 1400829577
• Copyright: 2009-03-01
• Publisher: Princeton Univ Pr

Summary

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.

Table of Contents

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