financial markets
TRANSCRIPT
Financial Markets
Economics 252
Robert Shiller
Introductory Lecture
Financial and Insurance as Powerful Forces in Our Economy
and Society
• This course seeks to understand the full role of advanced risk management in our economy and society
• Finance, insurance, some public finance
The Fundamental Role of Risk Management
• All manner of enterprise involves risk
• Difficulties in quantifying
• Judgment
• Financial theory provides an understanding of these risks
• Financial institutions provide a framework for applying theory
Moral Hazard
• Example: burning down a house to collect on fire insurance
• Ubiquity of moral hazard problems
• Practical finance has developed institutions to promote risk management while dealing with moral hazard
Major Financial Sectors
• Securities• Banks• Insurance• Social InsuranceAll of these have a long history of promoting
risk management and dealing with moral hazard. They are fundamental elements of our successful modern economy
Radical Financial Innovation
• Risks not easily conceptualized
• Public resistance to risk management
• Each major risk category requires difficult institutional innovations to manage
Democratization of Finance
• Trend over the centuries has been to apply financial and insurance principles to a broader and broader segment of population
• Advance of information technology
Finance and Psychology
• The Behavioral Finance Revolution
• NBER-Sage Seminars on Behavioral Finance, with Richard Thaler, starting 1991 http://www.econ.yale.edu/~shiller
• A Revolution in the finance profession. But not everyone has been captured by it.
Finance and Management
• Most central discipline for managers is finance
• Integration into all aspects of business management, including accounting, corporate strategy, industrial organization
• Integration into government finance as well
• Integration growing through time
Finance and Law
• Lawyers are often financial inventors
• Often government role in process
• Law schools deal with all the minutiae
Text #1: Foundations of Financial Markets and
Institutions• Frank J. Fabozzi, Author/Editor of 117 books,
publisher (Frank Fabozzi Associates), Adjunct Prof. Yale SOM
• Franco Modigliani, Prof. Of Economics and Finance Emeritus, MIT
• Frank J. Jones, Guardian Life Insurance Co. of America
• Michael G. Ferri. George Mason University• Entire book assigned
Text #2 Stocks for the Long RunJeremy Siegel, 1994, 1998, 2002
• Book is best known for making the case for stocks as best long-term investment
• But in fact offers a wide view of empirical literature on financial markets
Text #3 New Financial OrderRobert Shiller 2003
• Extrapolates trends from the past into the financial future
• Last 20 years saw massive financial innovation• Next 20 years will see even more financial
innovation• Financial theory offers a conceptual framework
for a broad advance in the depth of risk management
Packet of Readings for Econ252
• Audubon Copy Whitney Ave. Near Clark’s
• Required purchase
Lecture 2: The Universal Principle of Risk Management: Pooling and
Hedging of Risk• Origins of concept of probability
• Multiplication rule, law of large numbers is basis of risk management
• Examples of risk pooling in operation
• Review of basic statistical and associated economic concepts: Expected utility theory, variance, covariance regression analysis
Lecture 3: Technology and Invention in Finance
• Financial institutions are inventions as much as engines are
• Once discovered, inventions copied around the world
• Relation to new information technology
• Evolving role of patent law
Lecture 4: Insurance: The Archetypal Risk Management
Institution• Private insurance institutions were invented after
fire of London 1666• Role of discovery of probability theory in this
invention• The extension through time of insurance practice
into increasingly more realms of human risk• Modern insurance companies and their regulators
Lecture 5: Portfolio Diversification and Supporting
Financial Institutions• How risks are spread• Covariance with
market portfolio• Beta• Mutual fund theorem• Investment companies
and their management
Lecture 6: Efficient Markets and Excess Volatility
• Efficient Markets Hypothesis vs. Random walk
• Apparent inability of professionals to make money
• Warren Buffet and David Swensen: What does their experience prove?
Lecture 7: Behavioral Finance: The Role of Psychology
• Research in psychology
• Anomalies in finance
• Kahneman & Tversky: Prospect Theory
Lecture 8: Human Foibles, Manipulation and Regulation
• Louis Brandeis and insiders vs. outsiders
• Securities and Exchange Commission, 1934
• The battle against fraud
• Regulation around the world
Lecture 9: Debt Markets, Term Structure of Interest Rates
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Lecture 10: Corporate Equity: Earnings & Dividends
• Issues in dividend payout
• Modigliani-Miller theorem
• Historical changes in dividend-price ratios
• Financial innovation blurring the role of dividends
Lecture 11: Corporate Equity, Debt & Taxes
• Issues firms face in decided how much to borrow
• Modigliani Miller irrelevance theorem
• Historical changes in leverage
• Behavioral finance response to extreme version of Modigliani Miller
Lecture 12: Real Estate Finance Today and in the Future
• Risk management as practiced today in real estate• Efficiency of markets for houses, commercial real
estate• Real Estate Investment Trusts and existing other
institutions• New institutions: Home equity insurance, housing
partnerships, SAMs, Macro securities
Lecture 13: Banking in a Changing World
• Multiple expansion of credit• Money multiplier• Major banks of world, size distribution• Importance of banks in less developed
countries• Bank regulation, Basel Accord• Impact of information technology on
banking
Lecture 14: The Evolution and Perfection of Monetary Policy
• Board of Governors of Federal Reserve System has been model for world Central Banks
• Independent central bank and FOMC procedures adopted around the world
• Monetary Policy Rules• Effects of monetary policy on financial
markets
Lecture 15: Investment Banking and Secondary Markets
• The role of underwriters
• Directly placed offerings
• Regulation of investment banks
• Role of investment banks in financial innovation
Lecture 16: The Changing Role of Institutional Investing
• Objectives and risks facing institutional investors
• Limits to arbitrage
• Regulation and other forces operating on institutional investors
• Impacts on institutional investing of a changing financial world
Lecture 17: Brokerage, ECNs
• The traditional exchanges: New York Stock Exchange, Amex, regional exchanges
• Nasdaq and electronic exchanges
• The stock brokerage business
• Stock price indexes
• Spiders and other exchange-traded instruments
Lecture 18: Consumer Finance
• Credit cards, home equity loans, etc.
• Laws to protect consumers
• Rising levels of consumer debt, concerns about rising personal bankruptcy
• The transformation wrought by new information technology
Lecture 19: Forwards and Futures
• Forward contracts and their limitations
• Futures contracts since Osaka in 1600s
• Fair value
• Hedging function
• Failure to hedge
Lecture 20: Stock Index, Oil and Other Futures Markets
• The history of commodity futures• The evolution since 1980 of financial
futures• Stock index futures• Interest rate futures• Oil as a fundamental factor in world
economy• Innovation in the future
Lecture 21: Options Markets
• Definition of options
• Black-Scholes formula
• Chicago Board Options Exchange
• The use of options in hedging and speculation
• Increasing scope of options contracts in the future
Lecture 22: Other Derivative Markets
• Swaps, Swaptions
• Macro Securities and the American Stock Exchange
Lecture 23: Stock Market Booms & Crashes
• Stock market crash of 1929
• Stock market crash of 1987
• Mexican Crisis 1994
• Asian financial crisis 1997-1998
• Nasdaq crash 2000-2001
• Role of financial innovations in these crashes and in their likelihood in the future
In Memoriam: Brad Hoorn • Economics 252b Spring
2001• Graduated Yale 2001• Worked Fred Alger
Management, 93d Floor, World Trade Center, North Tower, Research Associate, Investment Management
• 35 of the 38 Alger employees at WTC were lost.