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MSc Economics

Year of entry: 2020

Course unit details:
Financial Economics II

Unit code ECON61262
Credit rating 15
Unit level FHEQ level 7 – master's degree or fourth year of an integrated master's degree
Teaching period(s) Semester 2
Offered by Economics
Available as a free choice unit? Yes


The aims of this course are to:

(i) introduce students to the allocation of risk in economic situations that involve uncertainty;

(ii) establish the link between economics and finance.

Learning outcomes

At the end of this course students should be able to demonstrate:

(i) an understanding of security pricing techniques;

(ii) an understanding of the analysis of the operation of financial markets using tools from economic analysis;

(iii) an ability to relate financial markets to the rest of the economic system


Beginning with a review of the standard general equilibrium theory, which will provide the context for the analysis, the course will proceed with the introduction of uncertainty and it will then cover arbitrage pricing theory. Topics include equilibrium with incomplete markets, which will be a good part of the course, the Capital Asset Pricing Model, the Modigliani-Miller theorem, the Black-Scholes options Pricing formula (in discrete time) and other asset pricing techniques, all of which pop out of the arbitrage pricing theory in competitive markets. An ambitious goal is to finish the course with the most recent developments on asset pricing in imperfectly competitive markets. All the topics will be covered in a rigorous way, making extensive use of mathematical models and techniques. Although empirical relevance will be emphasized whenever possible, the course does NOT cover applied and empirical work.

The course will proceed as follows:

1. Uncertainty and risk

  • states of nature
  • contingencies (events)
  • information
  • contingent goods, contingent plans
  • preferences over contingent plans
  • alternative notions of risk

2. Alternative institutional contexts of risk sharing

  • contingent markets
  • security markets
  • real/financial securities, bonds, stocks, options, derivative securities.

3. Individual behavior under uncertainty

  • the no arbitrage principle

4. Economies with uncertainty

  • contingent markets equilibrium
  • asset markets equilibrium, the no arbitrage property of asset prices
  • asset market completeness, equivalence between asset markets and contingent markets, optimality properties of complete asset structures and policy implications.
  • asset pricing techniques: arbitrage pricing theory, the capital asset pricing model
  • the Modigliani-Miller theorem of corporate finance.
  • incomplete asset markets, causes and consequences.
  • information, (rational) expectations.

Teaching and learning methods

Lectures and tutorials

Assessment methods

Method Weight
Written exam 100%

Recommended reading

An indicative reference for this material is the book ‘The Theory of Incomplete Markets’ by M. Magill and M. Quinzii (although the technical level of the course will be much lower than in that book). Another reference for the material in this course is the book ‘Security Markets, Stochastic Models’ by Darrell Duffie. This book is recommended for the more technically experienced students. More information about the incomplete markets literature can be found in a special issue devoted to this subject, inside the 1990-91 volume of the Journal of Mathematical Economics.

Study hours

Scheduled activity hours
Lectures 22
Tutorials 5
Independent study hours
Independent study 123

Teaching staff

Staff member Role
Leonidas Koutsougeras Unit coordinator

Additional notes

Pre-requiste: ECON20120/30320, ECON30432 or equivalent

Lectures - Wednesday 2 - 4pm
Tutorials - Wednesday 1 - 2pm


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