Economics of Financial Markets

ISBN-10: 0521612802
ISBN-13: 9780521612807
Edition: 2005
Authors: Roy E. Bailey
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Description: The Economics of Financial Markets presents a concise overview of capital markets, suitable for advanced undergraduates and for beginning graduate students in financial economics. Following a brief overview of financial markets - their  More...

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Book details

List price: $74.99
Copyright year: 2005
Publisher: Cambridge University Press
Publication date: 5/26/2005
Binding: Paperback
Pages: 550
Size: 6.75" wide x 9.50" long x 1.25" tall
Weight: 0.858
Language: English

The Economics of Financial Markets presents a concise overview of capital markets, suitable for advanced undergraduates and for beginning graduate students in financial economics. Following a brief overview of financial markets - their microstructure and the randomness of stock market prices - this textbook explores how the economics of uncertainty can be applied to financial decision-making. The mean-variance model of portfolio selection is discussed, with analysis extended to the capital asset pricing model (CAPM). Arbitrage plays a pivotal role in finance and is studied in a variety of contexts, including the APT model of asset prices. Methods for the empirical evaluation of CAPM and APT are also discussed, together with the volatility of asset prices, the intertemporal CAPM and the equity premium puzzle. An analysis of bond contracts leads into an assessment of theories of the term structure of interest rates. Finally, financial derivatives are explored, focusing on futures and options contracts.

R. E. Bailey is Reader in Economics at the University of Essex. His main interests are in monetary economics, together with economic history and philosophy.

List of figures
Preface
Asset markets and asset prices
Capital markets
Asset price determination: an introduction
The role of expectations
Performance risk, margins and short-selling
Arbitrage
The role of time
Asset market efficiency
Summary
Averages and indexes of stock prices
Real rates of return
Continuous compounding and the force of interest
References
Asset market microstructure
Financial markets: functions and participants
Trading mechanisms
Industrial organization of financial markets
Trading and asset prices in a call market
Bid-ask spreads: inventory-based models
Bid-ask spreads: information-based models
Summary
References
Predictability of prices and market efficiency
Using the past to predict the future
Informational efficiency
Patterns of information
Asset market anomalies
Event studies
Summary
The law of iterated expectations and martingales
References
Decision making under uncertainty
The state-preference approach
The expected utility hypothesis
Behavioural alternatives to the EUH
The mean-variance model
Summary
Useful notation
Derivation of the FVR
Implications of complete asset markets
Quadratic von Neumann-Morgenstern utility
The FVR in the mean-variance model
References
Portfolio selection: the mean-variance model
Mean-variance analysis: concepts and notation
Portfolio frontier: two risky assets
Portfolio frontier: many risky assets and no risk-free asset
Portfolio frontier: many risky assets with a risk-free asset
Optimal portfolio selection in the mean-variance model
Summary
Numerical example: two risky assets
Variance minimization: risky assets only
Variance minimization with a risk-free asset
Derivation of [Delta sigma subscript P] = [beta subscript jP sigma subscript P Delta]a[subscript j]
The optimal portfolio with a single risky asset
References
The capital asset pricing model
Assumptions of the CAPM
Asset market equilibrium
The characteristic line and the market model
The security market line
Risk premia and diversification
Extensions
Summary
The CAPM in terms of asset prices
Linear dependence of [epsilon subscript j] in the CAPM
The CAPM when all assets are risky
References
Arbitrage
Arbitrage in theory and practice
Arbitrage in an uncertain world
State prices and the risk-neutral valuation relationship
Summary
Implications of the arbitrage principle
References
Factor models and the arbitrage pricing theory
Factor models
APT
Predictions of the APT
Summary
The APT in a multifactor model
The APT in an exact single-factor model
References
Empirical appraisal of the CAPM and APT
The CAPM
Tests of the CAPM: time series
Tests of the CAPM: cross-sections
Sharpe ratios and Roll's criticism
Multiple-factor models and the APT
Summary
The Black CAPM in terms of excess returns
References
Present value relationships and price variability
Net present value
Asset price volatility
Behavioural finance, noise trading and models of dividend growth
Extreme asset price fluctuations
Summary
Present values in continuous time
Infinitely lived assets: constant growth
The RNVR with multiple time periods
References
Intertemporal choice and the equity premium puzzle
Consumption and investment in a two-period world with certainty
Uncertainty, multiple assets and long time horizons
Lifetime portfolio selection
The equity premium puzzle and the risk-free rate puzzle
Intertemporal capital asset pricing models
Summary
Intertemporal consumption and portfolio selection
Simplifying the FVR
The consumption CAPM
References
Bond markets and fixed-interest securities
What defines a bond?
Zero-coupon bonds
Coupon-paying bonds
Bond valuation
Risks in bond portfolios
Immunization of bond portfolios
Summary
Some algebra of bond yields
References
Term structure of interest rates
Yield curves
Index-linked bonds
Implicit forward rates
The expectations hypothesis of the term structure
Allowing for risk preferences in the term structure
Arbitrage and the term structure
Summary
The expectations hypothesis with explicit uncertainty
Risk aversion and bond portfolios
References
Futures markets I: fundamentals
Forward contracts and futures contracts
The operation of futures markets
Arbitrage between spot and forward prices
Arbitrage in foreign exchange markets
Repo markets
Summary and conclusion
Forward and futures prices
Revaluation of a forward contract
References
Futures markets II: speculation and hedging
Speculation
Hedging strategies
Optimal hedging
Theories of futures prices
Manipulation of futures markets
Summary
Futures investment as portfolio selection
Derivation of h
References
Futures markets III: applications
Weather futures
Financial futures contracts
Short-term interest rate futures
Long-term interest rate, or bond, futures
Stock index futures
The fall of Barings Bank
Summary
References
Swap contracts and swap markets
Swap agreements: the fundamentals
Why do swaps occur?
Risks associated with swaps
Valuation of swaps
Metallgesellschaft: a case study
Summary
References
Options markets I: fundamentals
Call options and put options
Varieties of options
Option-like assets
Upper and lower bounds for option prices
Put-call parity for European options
The Modigliani-Miller theorem
Summary
Lower bound for a European call option premium
Lower bound for a European put option premium
Put-call parity for European options
The Modigliani-Miller theorem: a proof
References
Options markets II: price determination
The fundamentals of option price models
A two-state option-pricing model
The Black-Scholes model
Contingent claims analysis
Summary
References
Options markets III: applications
Stock index options
Options on futures contracts
Interest rate options
Options and portfolio risks
Portfolio insurance
Combinations and spreads
Summary
Put-call parity for European options on futures
References
Subject index

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