ECON6055 Selected Topics in Investments and Asset Pricing

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1 ECON6055 Selected Topics in Investments and Asset Pricing July August 2009 Class venue: KK Leung LG1 Room 105 Class time: 6:45-9:45pm on specified dates Instructors: Hong Yan and Yongjun Tang Office: KKL 1001 (Dr. Yan); KKL 1005 (Dr. Tang) Office Hours: By appointment Course Description: This course provides in-depth coverage of topics in investments and asset pricing. The theory part will focus on discrete-time one-period and multi-period models and elaborate on topics including market equilibrium and the absence of arbitrage, complete and incomplete markets, portfolio theory and mean-variance analysis, consumption-based asset pricing models and the equity premium puzzle. The course will also cover topics on the recent development in the empirical literature. The objective of the course is to provide a foundation for students to conduct original research in financial economics. Course Learning Outcomes 1. Understand the basic constructs of asset pricing models. 2. Be familiar with model implications, testing approaches, and empirical evidence. 3. Get exposure to the frontier topics in asset pricing research. 4. Grasp basic skills for conducting independent research on asset pricing. Measurement of Learning Outcomes 1. A set of assignments will be given to students to work on themselves. The objective is to help them to better understand the concepts and methods introduced in class. 2. Students will be asked to write referee report to develop research skills. 3. A final exam will test students ability to apply the basic theory and methods learned in our class to analyze specific problems. 4. Students will be asked to write a research proposal leading to a formal research paper. 1

2 Alignment of Program and Course Learning Outcomes Program Learning Outcomes Course Learning Assessment Modes Outcomes To master current theory and knowledge in the 1, 3 Homework, Test, Report field of economics To master the skills to deal with economic data. 2, 3, 4 Homework, Test, Report Acquisition and internalization of knowledge 1, 2, 3 Homework, Test, Report and techniques in the discipline of modern Finance. To conduct quality research independently in 3, 4 Homework, Test, Report their area of specialization Mastering communication skills 1, 2, 3, 4 Homework, Test, Report Course Materials: Required Text: o Stephen F. LeRoy and Jan Werner, Principles of Financial Economics, Cambridge University Press, (LW) o John H. Cochrane, Asset Pricing, Revised Edition, Princeton University Press, (C) Recommended Classic References: o Chi-Fu Huang and Robert H. Litzenberger, Foundations for Financial Economics, Prentice-Hall, (HL) o John E. Ingersoll, Jr., Theory of Financial Decision Making, Rowman and Littlefield, (I) o John Y. Campbell, Andrew W. Lo and A. Craig MacKinlay, The Econometrics of Financial Markets, Princeton University Press, (CLM) Recommended New References: o Lo, Andrew W., and Robert C. Merton (eds.), 2009, Annual Reviews of Financial Economics, forthcoming. o Back, Kerry, 2009, Asset Pricing and Portfolio Choice Theory, Oxford University Press, forthcoming. o Leland, Hayne, 2009, Structural Models in Corporate Finance, Princeton University Press, forthcoming. o Skiadas, Costis, 2009, Asset Pricing Theory, Princeton University Press. o Ross, Stephen, 2007, Neoclassical Finance, Princeton University Press. o Pennacchi, George, 2007, Theory of Asset Pricing. o Singleton, Kenneth, 2006, Empirical Dynamic Asset Pricing. o Duffie, Darrell, 2003, Dynamic Asset Pricing Theory (3 rd edition). o Constantinides, George, Milton Harris, and René Stulz, 2003, Handbook of the Economics of Finance. o Campbell, John, and Luis Viceira, 2002, Strategic Asset Allocation. o Bossaerts, Peter, 2002, The Paradox of Asset Pricing, Princeton University Press. Lecture notes and other materials will be available for the class. 2

3 Grading Policy: The overall grade for this course will be based on the following components: Problem Sets: 30% Referee Report: 10% Class Participation: 10% Final Exam: 30% Research Proposal: 20% The research proposal should pave the road to a full-blown research paper. For undergraduate students interested in applying for graduate schools, this is often a key element in the application package. Academic Integrity: Every HKU student is responsible for upholding the provisions of the University Regulations on Academic Dishonesty, which addresses the University s policy on academic honesty, including provisions regarding plagiarism (see for definitions) and cheating, unauthorized access to University materials, misrepresentation/falsification of University records or academic work, malicious removal, or destruction of materials, malicious/intentional misuse of computer facilities and/or services, and misuse of student identification cards. Incidents of alleged academic misconduct will be handled through the established procedures of the University Board of Examiners and the Senate, which includes either an informal resolution by a faculty member, resulting in a grade adjustment, or a formal hearing procedure, which may subject a student to a minimum one semester suspension requirement. 3

4 Course Outline: The course will follow the LeRoy-Werner (LW) and the Cochrane (C) texts for the first eight sessions, with supplementary materials from other texts and articles. The following is a tentative list of topics covered in the class. This outline may be updated later. Date Instructor Topic Reading Part I: Individual Choice under Uncertainty 7/13 Yan Equilibrium, Arbitrage, and Valuation LW 1-7; C 1-4; HL 5 Merton (AE 2006) 7/14 Yan Risk, Utility, and Optimization LW 8-13; HL 1-2 Lo (JPM 2004) Part II: Equilibrium Asset Pricing 7/21 Yan Equilibrium Price and Allocation LW 14-16; HL 6 7/22 Yan Mean-Variance Analysis LW 17-18; HL 3 7/23 Yan Factor Pricing LW 19-20; HL 4 7/28 Yan Multi-period Equilibrium LW 21&23; HL 7 7/29 Yan No-Arbitrage LW 22, 24-26; HL 8 7/30 Yan Consumption CAPM LW 27-28; HL 7; I Equity Premium Puzzle CLM 8; C21 Part III: Estimation and Evaluation; New Theories 8/3 Tang Asset Pricing Tests Lewellen, Nagel, and Shanken (JFE 2009) Kan and Robotti (RFS 2009) Li, Xu, and Zhang (JFE 2009) Nagel and Singleton (WP 2009) Petersen (RFS 2009) Chen and Zhang (JF 2009) 4

5 8/5 Tang Long Run Risk Bansal and Yaron (JF 2004) Hansen, Heaton, and Li (JPE 2008) Beeler and Campbell (WP 2009) Malloy, Moskowitz, and Vissing- Jorgensen (JF 2009) 8/10 Tang Structural Models Almeida and Philippon (JF 2008) Korteweg (JF 2009) Berk, Green, and Naik (JF 1999) Chen, Collin-Dufresne, and Goldstein (RFS 2008) 8/12 Tang New Theories: (1) Ambiguity Chapman and Polkovnichenko (JF 2009) (2) Consumption Commitment (3) Limited Attention This outline is preliminary and subject to change. 5

6 References Bansal, Ravi, and Amir Yaron, 2004, Risks for the long run, Journal of Finance 59, Beeler, Jason, and John Y. Campbell, 2009, The long run risks model and aggregate asset prices: An empirical assessment, Working paper, Harvard University. Berk, Jonathan B., Richard C. Green, and Vasant Naik, 1999, Optimal investment, growth options and security returns, Journal of Finance 54, Chapman, David, and Valery Polkovnichenko, 2009, First-order risk aversion, heterogeneity, and asset market outcomes, Journal of Finance, forthcoming. Chen, Long, and Zhang Lu, 2009, A better three-factor model that explains more anomalies, Journal of Finance, forthcoming. Hansen, Lars Peter, John C. Heaton, and Nan Li, 2008, Consumption strikes back?: Measuring long-run risk, Journal of Political Economy 116, Kan, Raymond, and Cesare Robotti, 2009, Model comparison using the Hansen-Jagannathan distance, Review of Financial Studies, forthcoming. Korteweg, Arthur, 2009, The net benefits of leverage, Journal of Finance, forthcoming. Lewellen, Jonathan, Stefan Nagel, and Jay Shanken, 2009, A skeptical appraisal of asset pricing tests, Journal of Financial Economics, forthcoming. Li, Haitao, Yuewu Xu, and Xiaoyan Zhang, 2009, Evaluating asset pricing models using the second Hansen-Jagannathan distance, Journal of Financial Economics, forthcoming. Lo, Andrew W., 2004, The adaptive markets hypothesis, Journal of Portfolio Management, 30 th Anniversary Issue, Malloy, Christopher J., Tobias J. Moskowitz, and Annette Vissing-Jorgensen, 2009, Long-run stockholder consumption risk and asset returns, Journal of Finance, forthcoming. Merton, Robert C., 2006, Paul Samuelson and financial economics, The American Economists 50(2), Nagel, Stefan, and Kenneth Singleton, 2009, Estimation and evaluation of conditional asset pricing models, Working paper, Stanford GSB. Tetlock, Paul C., 2007, Giving content to investor sentiment: The role of media in the stock market, Journal of Finance 62,