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Advanced Finance (Subject) / Finance (Lesson)
- Novel Prizes for financial economists 1970 l Dynamic economic Theory 1972 l Kenneth Arrow General economic equilibrium theory 1983 l Debreu : Theory of general equilibrium 1985 l Markowitz Modigliani : Analysis of financial markets 1990 Meron Miller : Theory of financial economics 1994 l Nash : Game theory 1997 l Myron Scholes : New method to determine the value of derivatives
- Market Efficiency also called Efficient Market Hypothesis (EMH) a theory discovered ’by accident’ in 1950s explains why important study-objects as stock price changes should be unpredictable! Essence was accurately and succinctly worded by Samuelson: Properly anticipated prices fluctuate randomly
- Central issue is valuation of investment projects, firms, options, contracts, etc. In finance, value is often the discounted value of expected future Uncertainty can be accounted for in 3 different ways: 1. Adjust the discount rate to the risk adjusted discount rate using the Capital Asset Pricing Model (CAPM) or Ross’ Arbitrage Pricing Theory (APT) 2 Adjust the cash flows to certainty equivalent cash flows using the CAPM or derivative securities such as futures 3 Adjust the probabilities (expectations operator) from normal to risk neutral or equivalent martingale probabilities using the Black-Scholes-Merton Option Pricing Theory, a fundamentally different way to account for risk.
- Economic depreciation changes from year to year depending on how much of project is realized but return is constant In accounting representation depreciation is arbitrarily set as a constant so that return jumps up and down makes second year exceptionally good (bonuses?) Example project re-used later in marked efficiency
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