Welcome to Investments, Tue. Mar. 31, ’09 Today’s plan: Practical info; text-book, APSIM, hand- ins, lectures, exam, … Scientific content; the big picture and Sharpe’s Chapter 1. Trading and equilibrium in a simple state- preference model; Sharpe’s Chapter 2.

Practical Matters, I Text-book: W. Sharpe (200[6-7-8]), ”Investors and Markets”, Princeton (and just that). Important tool: The APSIM-program which is a (C++-based) Excel plug-in. Get that working on your computer. (Installation problem-free on my XP-laptop. C-drive- acces; Excel security-level. FinLab- computers, Vista, Linux, Mac … ?)

Practical Matters, II Use Kursportalen and this frequently.Kursportalenthis The lecture plan is irregular for a number of reasons. Lectures will be a mixture of slides, Excel and blackboard. And I will try to mix it up with some tutorial-like parts.

Practical Matters, III This week: 3 hours of me talking on Tuesday (March 31) and Thursday (April 2) to get the ball rolling. Then 1st hand-in exercise is posted, and you work on that on Friday (i.e. no lectures on March 3).

Practical Matters, IV: Evaluation Of me: Standard procedure, but running feedback is appreciated. Of you: Two mandatory Hand-Ins and a final written exam on May 29. The Hand-In deadlines will be April 17 and May 8. Groups of up to three are allowed.

Scientific Contents, I You have had courses in microeconomics. Did you think that the dicussion of general equlibrium was too abstract? seen CAPM. Did you think that the equilibirum considerations were partial at best? seen (binomial-model) option-pricing. Did you ever wonder why there are markets for options?

Scientific Contents, II Well, that is what we going to fix. The more dull version is that we study portfolio choice, asset prices and equilibrium in state- preference models. One period, finite #outcomes makes the math (although not necessarily the algebra) simple. Our approach: Experimental; or ”simulation” as Sharpe says.(”Numerical”, ”empirical” could be used too.)

Scientific Contents, III: Sharpe Ch. 2: Trade-to-equilibrium in a simple model. Ch. 3 (Preferences) and 4 (Prices) is ”standard text-book stuff”, but with twists. We uncover details of the trading process. Ch. 5 (Positions): Standard texts mention ”wealth and utility heterogeneity” but usually don’t do anything about it.

Scinetific Contenst, IV: Sharpe Ch. 6 (Predictions): What if people differ in their the assesments of probabilities? Theory is tricky, experiments are easy. Ch. 7 (Protection): Introducing option-like structures and finding both buyers and sellers.(Meaningful financial engineering.) Ch. 8 (Advice): Uncovering people’s preferences.

Sharpe’s Chapter 2 Market Risk-Reward Theorem (MRRT) Only market risk is rewarded with a higher expected return. You are not rewarded for taking risk that could be diversified away. A very sobering principle. If you think ”market risk” is vague: fair enough, just hang on for a little while. CAPM is one case where MRRT holds. (Here, the expected return relation is linear; it needn’t be)