B2217 - MACROFINANCE

Learning outcomes

At the end of the course, the student will have learned the main techniques needed for the analysis of the price movements in financial markets and their decomposition in terms of factor premia and market expectations, being able to evaluate financial products both under the “physical” measure P and the “risk neutral” measure Q. The student will also master the main issues of the impact of the macroeconomy on financial markets and vice versa. In particular he will be required to have adequate knowledge of the main techniques of risk measurement at the macroeconomic level, articulated in terms of systemic risk and contagion, in the relationship among sovereign entities, the financial sector and the real economy. Based on a sound knowledge of theoretical and technical aspects, the student will attain a personal and critical view of the unfolding of financial crises and the future long term risk drivers of the macroeconomy, including climate change and other secular topics.

Course contents

1. Asset pricing: no arbitrage under measure P and Q
   • Measure P and the risk-premium
   • Measure Q and martingale pricing
   • AI and risk premia
     
2. Stochastic discount factor (SDF)
   • SDF and no-arbitrage under measure P
   • Mean-variance model and SDF
   • SDF in the consumption/investment model
3. Habit formation models
   • Equity premium puzzle
   • Habit formation
   • Extensions
4. Recursive utility models
   • SDF with recursive utility
   • Long run risk and preference for early resolution
   • Climate change application
5. Long term investment and Growth Optimal Portfolio (GOP)
   • The information theory view: Kelly rule
   • The expected utility view: Samuelson fallacy
   • Log-wealth maximization and Growth Optimal Portfolio (GOP)
6. Long term risk
   • Dybvig-Ingersoll-Ross theorem and the asymptotic interest rate
   • Persistent shocks and long term interest rates
   • Term structure shapes: risk-free and dividends
7. Implied information in derivatives
   • Option pricing and implied information
   • Information in the volatility smile/skew
   • Implied volatility and policy shocks
8. Monetary policy effects
   • The impact of central bank announcements
   • Monetary shocks identification
   • Impact on bonds and stocks
9. Credit risk information
   • Credit spreads and the CDS market
   • Credit risk models: structural vs intensity based
   • Contagion: copula functions
10. Rare disasters and systemic crises
    • “Rare disasters” theory
    • Marshall-Olkin models
    • Application to climate change risk

Readings/Bibliography

Selected Chapters in Books

John H. Cochrane: Asset Pricing, 2009 Princeton University Press

John Y. Campbell, Andrew W. Lo and A. Craig MacKinlay, The Econometrics of Financial Markets, 1999 Princeton University Press,

Main Reference Articles

John H. Cochrane: Macrofinance, 2017, Review of Finance, 945-985

John Y. Campbell: Asset Pricing at the Millennium, 2000, Journal of Finance, 1515-1567

Main topic articles

John L. Kelly: A new interpretation of information rate, 1956, Bell System Technical Journal, 35, 917-26

Stephen A. Ross: Adding risks: Samuelson's fallacy of large numbers revisited, 1999, Journal of Financial and Quantitative Analysis, 34(3), 323-339

Larry G. Epstein, Stanley E. Zin: Substitution, risk aversion and the temporal behavior of consumption and asset returns: an empirical analysis, 1991, Journal of Political Economy, 99(2), 263-286

John Y. Campbell, John H. Cochrane: By force of habit: a consumption-based explanation of aggregate stock market behavior, 1999, Journal of Political Economy,107(2), 205-251

Ravi Bansal, Amir Yaron: Risks for the long run: a potential resolution for asset pricing puzzles, 2004, Journal of Finance, 59(4), 1481-1509

Robert J. Barro: Rare disasters and asset markets in the twentieth century, 2006, The Quartely Journal of Economics, 823-866

F. Alvarez, Urban J. Jermann, Using asset prices to measure the persistence of marginal utility of wealth, Econometrica, 73(6), 1977-2016

R.S. Gürkaynak, B. Sack, E. Swanson: Do actions speak louder than words? The response of asset prices to monetary policy actions and statements, 2005, International Journal of Central Banking, 1(1), 55-93

Teaching methods

Lectures

Assessment methods

The exam will be based on:

1. a term paper (and a PPT or PDF presentation)
   
2. an oral examination.

The term paper will be sent 5 days before the exam, which will be individual and consist of

1. 15 minute presentation of the term paper (with PPT or PDF)
2. 10-15 minutes of questions on content of the course.
   

The term paper will account for up to 6 points in the final grade.

The term paper (about 10 pages) should consist of

1. an introduction to the problem or topic chosen
2. a review of the literature on the subject
3. a mathematical treatment of the problem
4. an illustrative example with data, either real or simulated

The maximum possible score is 30 cum laude.

The grades are described as follows

< 18 failed

18-23 sufficient

24-27 good

28-30 very good

30 cum laude Excellent

Teaching tools

Slides.

Office hours

See the website of Umberto Cherubini