Theory of Finance

Module code: EC7084

This module is designed to introduce the fundamental concepts and techniques used in modern finance theory. We will focus on the foundations of the equilibrium models of asset pricing rather than the arbitrage pricing theory, which is the other main pricing approach in finance.

The module will begin with foundations of individual economic agent’s choice problem under uncertainty, followed by mean-variance analysis and the CAPM. Then we will examine general equilibrium analysis for asset pricing, in particular the Arrow- Debreu framework of finite agents, finite commodities and finite horizon economy. Based on the Arrow-Debreu framework, foundations of risk neutral pricing will be provided in the general equilibrium context. Finally, we will discuss extensions to more generic dynamical models.

Topics covered

  • Expected Utility Representation of Preferences
  • Measures of Risk Aversion
  • Stochastic Dominance
  • Mean-Variance Analysis and the CAPM
  • The Arrow-Debreu Model
  • Risk Neutral Pricing