THEORY OF ASSET PRICING

The course aims at providing a deeper understanding of how asset prices are determined both in the cross-section and during the business cycle. We start with the basic model of discounting future cash flows with constant discount factors. Then, we extend the model to time-varying discount factors and discuss the role of expectations about future cash flows and returns on current prices.

In the next step, we derive the stochastic discount factor from the consumption based Capital Asset Pricing Model. Based on this model, we derive the CAPM, ICAPM and APT as special cases. Finally, we extend the basic model to include long-run risks and derive the hedging demand component of agents’ portfolios related to these risks.