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Microfoundations of Financial Economics: An Introduction to General Equilibrium Asset Pricing

by Yvan Lengwiler Princeton University Press
Pub Date:
04/2006
ISBN:
9780691126319
Format:
Pbk 304 pages
Price:
AU$154.00 NZ$158.26
Product Status: In Stock Now
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This textbook takes the reader from the level of microeconomics principles through to modern asset pricing theory. Yvan Lengwiler elegantly links together issues that have in the past been the territory of general economic theorists on the one hand, and financial economists on the other. In a sequence of carefully explained steps, the reader learns how the first welfare theorem is used in asset pricing theory. The book then moves on to explore Radner economies and von Neumann-Morgenstern decision theory, and this section culminates in Wilson's mutuality principle and the consumption-based CAPM. This is then put into a dynamic setting, and term structure models are introduced. The empirical shortcomings of the standard asset pricing models are extensively discussed, as is research from the last twenty years aimed at bringing theory in line with reality. The reader is brought up to date on the latest areas of concern, such as habit formation, the consequences of heterogeneity, demographic effects, changing tax regimes, market frictions, and the implications of prospect theory for asset pricing. Aimed at masters or Ph.D. students specializing in financial economics, the book can also be used as a supplementary text for students of macroeconomics at this advanced level and will be of interest to finance professionals with a background in economics and mathematics. It includes problems (with solutions), and an accompanying website provides supporting material for lecturers.

Endorsements: 'Microfoundations of Financial Economics is a wonderful book. In less than 300 pages of highly readable text, Yvan Lengwiler covers the basics of modern asset pricing theory. Students of advanced finance will want to use this book as an effective learning tool and reference. It's going to be a permanent part of my library.'--Simon Benninga, Tel Aviv University and , Editor-in-Chief, European Finance Review 'A tour de force. Yvan Lengwiler's book provides a valuable structure around an area that professors struggle to cover in an integrated way.'--Elroy Dimson, London Business School


List of boxes xi

Preface xiii

1 Introduction 1

1.1 What Finance theory is about 1

1.2 Some history of thought 2

1.3 The importance of the puzzles 7

1.4 Outline of the book 9

2 Contingent claim economy 10

2.1 The commodity space 10

2.2 Preferences and ordinal utility 14

2.3 Maximization 16

2.4 General equilibrium 23

2.5 The representative agent 32

Notes on the literature 35

Problems 35

3 Asset economy 37

3.1 Financial assets 37

3.2 Pricing by redundancy 41

3.3 Radner economies 46

3.4 Complete markets (and uniqueness of Arrow prices) 53

3.5 Complications arising from market incompleteness 60

Notes on the literature 65

Problems 65

4 Risky decisions 68

4.1 Bernoulli's St.Petersburg paradox 69

4.2 Using more structure: probabilities and lotteries 71

4.3 The von Neumann -Morgenstern representation 75

4.4 Measures of risk preference 81

4.5 Assumptions and evidence 86

4.6 Often used specifications 91

Notes on the literature 99

Problems 99

5 Staticfinance economy 102

5.1 An economy with von Neumann -Morgenstern agents 102

5.2 Efficient risk-sharing 107

5.3 A representative NM agent 112

5.4 Who holds what kind of portfolio? 121

5.5 The stochastic discount factor 126

5.6 The equilibrium price of time 130

5.7 The equilibrium price of risk 132

5.8 Some important special cases 134

Notes on the literature 138

Problems 138

6 Dynamicfinance economy 141

6.1 A static dynamic model 141

6.2 Dynamic trading 149

6.3 Models of the real interest rate 162

6.4 Portfolio selection 168

Notes on the literature 170

Problems 170

7 Empirics and the puzzles 172

7.1 Collecting the right data 172

7.2 The equity premium puzzle 176

7.3 Alternative interpretations of the data 184

7.4 Excessive volatility 192

7.5 Anomalies 197

Notes on the literature 198

8 Adapting the theory 199

8.1 Assumptions of the mainstream model 199

8.2 Non-standard preferences 201

8.3 Heterogeneity 214

8.4 Efficiency failure 225

Notes on the literature 238

9 Epilog 239

9.1 A mystery 240

9.2 A challenge 241

9.3 The party's over 242

Appendix A Symbols and notation 245

Appendix B Solutions to the problem sets 247

Bibliography 269

Index 285

A tour de force. Yvan Lengwiler's book provides a valuable structure around an area that professors struggle to cover in an integrated way. Elroy Dimson, London Business School, co-author of 'Triumph of the Optimists' Microfoundations of Financial Economics is a wonderful book. In less than 300 pages of highly readable text, Yvan Lengwiler covers the basics of modern asset pricing theory. Students of advanced finance will want to use this book as an effective learning tool and reference. It's going to be a permanent part of my library. Simon Benninga, Tel Aviv University and , Editor-in-Chief European Finance Review This book can be a great asset for Ph.D. students that are overwhelmed by asset pricing. . . . Lengwiler produced a nice addition to recent publications that bridge the gap between undergraduate and advanced Ph.D. textbooks. EconomicDynamics Newsletter
Yvan Lengwiler is Assistant Professor of Economics at the University of Basel and Lecturer of Economics at the University of Zurich. He has published articles on general equilibrium theory, asset pricing, and auction theory in Economic Theory, the Journal of Monetary Economics, and other publications.