This is the module outline for EC4024, Financial Economics, Spring 2012

Instructor: Stephen Kinsella.

Contact: Stephen.Kinsella@ul.ie, phone +353 61 23 3611. Office hours 9-11 Wednesdays. No need to make an appointment, just show up. If you need to send me an email please see my email policy first. No I'm not kidding about that.

Introduction. The chart below shows the Dow Jones (^DJI) against the Irish Stock Exchange (^ISEQ) and the S&P 500 (^GSPC) over the last 5 years. I don't need to tell you something has gone very wrong in world financial markets. This module will help you understand a part of the reason things have gone so wrong.

Learning Objectives. This module is firstly an introduction to the jargon of finance. Secondly, I'd like you to have a sense of how finance and the financial industry connects to the real economy, especially during times of crisis. Third, I'd like you to see some simple financial models and ratios, and to understand them, and to have a look at some of the frontiers of financial modeling at the end.

Module Organization. This module will proceed in roughly three pieces. The first piece, lecture one, will be the jargon lecture. I'll give you examples of what I'm talking about as we go along. The second piece, lectures two to five, will contain the 'macro meets finance and regulation' stuff. The third piece, lectures six to eleven, will contain the finance theory and some empirics. Lecture 12 will be a recap. A full outline of all tutorials is here.

Assessment. You'll do a project for me, due at the start of Week 5 worth 40%. Guidelines on the data project are here. A template file for the data project is here. Here's an example of the type of thing I'd like to see. Feedback will be given on all submitted projects through Turnitin. Guidance on Turnitin will be provided in Tutorials. KBS grading bands are here. Update 13/2/2012: A guide for submission to Turnitin including class codes etc is here. Late projects will incur a 99% late penalty for each day of lateness. There will be a final exam worth 60% of your grade. Here is a sample exam for the module. 

Administration Slides for the entire module are here. I'll give out handouts during certain lectures, and recordings will be up on this site after the lectures, obviously. Recommended readings by lecture are below each heading as .pdfs or are housed as ebooks within the library catalogue. All projects will be checked with Turnitin. Tutorials from Weeks 2 to 5 will focus on preparing you for the project submission. Weeks 6 to 11 will focus on getting the theoretical tools of finance properly under your belts. You can't critique something you don't understand. Also, read the works of respected market practitioners. It's important to place the theoretical views we study here in their current context. For example, the maths for debt sustainability can be very boring, unless you realize getting things wrong could result in real world misery for a lot of people. So, have a read of

Lecture Outline

Part 1. Jargon

Lecture 1: Data, terminology, theory, and `the market'.

• M.F.M Osborne, The Stock Market from a Physicist’s Viewpoint, Crossgar Press, 1977 Chapters 2 and 3.
• J. L. McCauley. Dynamics of Markets: Econophysics and Finance from a Physicist’s Standpoint. Cambridge University Press, 2009, Chapters 1 and 2

Part 2. Finance and Macroeconomics

Lecture 2: Macroeconomics, Finance, and Regulation.

• John. R. Hicks 'Mr. Keynes and the "Classics"; A Suggested Interpretation, Econometrica Vol. 5, No. 2 (Apr., 1937), pp. 147-159 (Link)
• Ben S. Bernanke and Alan S. Blinder, Credit, Money, and Aggregate Demand, The American Economic Review, Vol. 78, No. 2, Papers and Proceedings of the OneHundredth Annual Meeting of the American Economic Association (May, 1988), pp. 435-439 (link)
• Philip Lane "Some Lessons for Fiscal Policy from the Financial Crisis," Nordic Economic Policy Review1(1), 13-34, 2010.(link)

Lecture 3: Banking, regulation, and crises: Minsky strikes back.

• The ECB's Balance Sheet.
• Patrick Honohan: Bank Failures: The Limits of Risk Modelling
• Richard Koo, The Holy Grail of Macroeconomics. Lessons from Japan's Great Recession, Wiley Press, 2009, ebook in Library
• Hyman Minsky, “Stabilizing an Unstable Economy” , McGraw Hill, 1986[2005], ebook in Library
• Stephen Kinsella, Financial Fragility and Corporate Governance in Ireland, in Ronan Keane and Ailbhe O’Neal, (eds), Corporate Governance: An Irish Perspective, Roundhall Press, 2009 pgs. 147-170. Draft version here.
• Stephen Kinsella and Vincent O’Sullivan(in press) Financial and Regulatory Failure: The Case of Ireland, Journal of Banking Regulation. (link)

Lecture 4. The ECB, EMU and Ireland: Macro-Finance perspectives.

• Ze Troika, EU/IMF Programme of Financial Support for Ireland, (link)
• Philip Lane and Patrick Honohan, Exchange Rates and Inflation under EMU: An Update, Economic Policy web essay, 2004.
• Carlo Altavill and Paul De Grauwe (2010): Forecasting and combining competing models of exchange rate determination, Applied Economics, 42, 3455-3480
• Paul De Grauwe (2009): The Fragility of the Eurozone’s Institutions, Open Economies Review, 21 (1), pp.167-174
• De Grauwe, P. (2006): Flaws in the design of the Eurosystem, International Finance, 9:1, pp.137-144.

Part 3: Portfolio theory, Zombie finance, fat tails

Lecture 5: Probability and stochastic processes. (Project due at the start of week 5.).

• C. Grinstead and J. Laurie Snell, Introduction to Probability (link)
• Probability and Finance, It’s Only a Game, Chapter 1
• Stephen Ross, Introduction to Finance, Chapters 1 and 2 (ebook through library portal)

Lecture 6: Zombie theories of finance.

• Anne Villamil, Modigliani Miller Theorem, New Palgrave Dictionary of Economics, link.
• André F. Perold The Capital Asset Pricing Model The Journal of Economic Perspectives, Vol. 18, No. 3. (Summer, 2004), pp. 3-24.
• Martin A. Leibowitz, Alpha Hunters and Beta Grazers, Financial Analysts Journal, Vol. 61, No. 5, pp. 32-39, September/October 2005

Lecture 7. Option theory for fun (and occasionally profit).

• Robert K. Merton Theory of Rational Option Pricing, Bell Journal of Economics and Management Vol. 4(1) 141-183 (link)
• K. Pilbeam, Finance and Financial Markets, 3rd Ed, Palgrave, 2009, Chapters 15 and 16 (ebook in Library)

Lecture 8: Fat tailed finance or: what happens when things go very wrong.

• B. Mandelbrot and R. Hudson. The (Mis)Behaviour of Markets, Basic Books, 2004, ebook in UL Library.
• NN Taleb, What Caused the 2008 Crisis? Collected Technical Papers, 2011.
• NN Taleb, Errors, Robustness, and the Fourth Quadrant, International Journal of Forecasting, 2009, 25(4), 744-759, also in Collected Technical Papers, 2011.
• Aaron Clauset, Cosma Rohilla Shalizi, M. E. J. Newman [0706.1062] Power-law distributions in empirical data, SIAM Review 51, 661-703 (2009)
• LA Adamic Zipf, Power-law, Pareto - a ranking tutorial

Lecture 9: Bond markets, and bond pricing.

• K. Pilbeam, Finance and Financial Markets, 3rd Ed, Palgrave, 2009, chapter 6.
• Tamim Bayoumi, Morris Goldstein and Geoffrey Woglom Do Credit Markets Discipline Sovereign Borrowers? Evidence from U.S. States (link)
• Journal of Money, Credit and Banking Vol. 27, No. 4, Part 1 (Nov., 1995), pp. 1046-1059 (link)
• Adrian Blundell-Wignall and Patrick Slovik, A Market Perspective on the European Sovereign Debt and Banking Crisis OECD Journal: Financial Market Trends Volume 2010 – Issue 2, (link)

Lecture 10: Theories of the exchange rate.

• K. Pilbeam, Finance and Financial Markets, 3rd Ed, Palgrave, 2009, chapters 5, 7.
• Maurice Obstfeld (2001), "International Macroeconomics: Beyond the Mundell-Fleming Model," International Monetary Fund Staff Papers 48, Special Issue 2001.(link)

Lecture 11: Frontiers: Finance without Probability Theory (watch a recording of the lecture here)

• Shafer, G. and Vovk, V. Probability and Finance: It’s only a game! Wiley (ebook), Chapters 1, 9
• "The game-theoretic Capital Asset Pricing Model", by Vladimir Vovk and Glenn Shafer (March 2002): pdf

Lecture 12. Recap