Asset Pricing

This is an old course, not taught since 2019. The material below is kept for reference.

Objective. The aim of this course is to provide you with a general view of asset pricing from the basic theory to empirical methods. This is a semester long course, but will feel more like two quarter-long courses in one… I promise it will be demanding. It is the only asset pricing course in our MA/Ph.D. program and I will cover all I believe to be important in the field. The focus will be in equilibrium models with rational agents in discrete time and, of course, the testing of these models. However, we will also have the opportunity to learn continuous time models and discuss anomalies and behavioural finance.

Classes, videos and the Asset Pricing Reading Group. As any course, we will have regular classes (45hrs) but students will also be required to attend our weekly Asset Pricing Reading Group, where current MA/Ph.D. students and sometimes old students now in the industry present on a weekly basis two papers on various topics related to this class (20 hrs). In the semester I teach this course, I use the Reading Group as the forum to discuss anomalies and behavioural finance. In the other semester, we focus on recent working papers on all areas of asset pricing. I also encourage you to watch all videos kindly provided by Prof. John Cochrane (8hs), originally from his Coursera course. We will go into a lot more detail and the videos cover only part of the topics we will discuss in classes, but they are amazingly clear and objective.

Class evaluation. Your final grade will be based on a risky and uncertain combination of: 1) written exam; 2) referee report of a recent working paper; 3) three empirical projects (including the replication/variation of two classic papers) and 4) at least two presentations of classic and recent papers. Problem sets will not count towards your final grade but are highly recommended. As a Finance student, you are required not to be afraid of risk and uncertainty, but your instructor knows the weights…

Readings. As we progress, we will transition from books to papers. We will use parts of all books below, but we will focus on the first two. The order tells you which books we will use the most.

• Cochrane, J., Asset Pricing, Revised edition 2005.
• Campbell, John Y., Financial Decisions and Markets: A Course in Asset Pricing.
• Back, K., Asset Pricing and Portfolio Choice Theory.
• Munk, C., Financial Asset Pricing Theory.
• Huang, C. F. and R. Litzenberger, Foundations for Financial Economics.
• Campbell, J.Y., Lo, A. W. and A. Craig MacKinlay, The Econometrics of Financial Markets.

Detailed outline. I will not assume you know the basic stuff, so I will review it whenever necessary (continuous time review; time series review; basic portfolio theory).

1. What we want to explain: time series and cross-section patterns in asset returns; value effect and other patterns; business cycle and returns; basic consumption-based model and its many failures (equity premium); classic issues in finance (means, variances, expected returns, betas and so on).
2. All the basic theory: general equilibrium; contingent claims and risk-neutral probabilities; state-space representation, risk sharing, aggregation; Law of One Price; arbitrage; existence of a discount factor; existence of a positive discount factor; mean-variance frontier: the old and the new; beta representations; relationship between discount factor, mean-variance and beta representations; conditioning information.
3. Cross-sectional models and how we test them: factor pricing models: CAPM, ICAPM, APT; conditional models; value and all the other premia; 3-factor and 5-factor Fama-French models; data mining; testing all the models.
4. Beyond the basics: shrinking the cross-section; zoo of factors; machine learning; term structure of equity risk premium; risk premium lower bounds; DSGE and finance.
5. Non-linear stuff: option pricing; variance swaps; simple variance swaps; variance risk premium and term structure of variance risk premium.
6. Fixed income but tough anyway: term structure definitions, expectations hypothesis; factor structure in bond yields and returns; term structure models: Vasicek, CIR and all that; macro-based models: Ang and Piazzesi and beyond; fixed income and FX.
7. Time dimension: predictability and volatility; Campbell-Shiller and others; bond predictability; Cochrane and Piazzesi and critics.
8. Changing the basic setup: consumption-based models; other utility functions; frictions; heterogeneity; long-run risk models; and more.
9. Is all the above wrong: behavioural models; limits of arbitrage; anomalies.