Theoretical Asset Pricing

This course initiates students to the economic principles behind models of rational valuation and investment choice. To be able to explain how assets are priced, we need to understand how economic agents optimally share their wealth between consumption, savings and investment. As choosing a portfolio of assets is equivalent to choosing various types of financial and/or macroeconomic risks to face with, we learn how the attitude towards risk of economic agents determines investment decisions and impose restrictions on asset prices that lead to the characterization of risk premiums. The main focus is on the relationship between arbitrage and equilibrium, and how both conditions imply the existence of “state prices”, positive discount factors such that the price of any security is simply its discounted expected payoff. All asset prices are then shown to be bundles/portfolios of state prices; debt; stocks, bonds, derivatives, etc. We start with examining static economies then extend into a multi-period framework. Both parts are restricted to discrete time and symmetric and complete information.