Financial economics is the branch of economics concerned with "the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment".[1] It is additionally characterised by its "concentration on monetary activities", in which "money of one type or another is likely to appear on both sides of a trade".[2] The questions within financial economics are typically framed in terms of "time, uncertainty, options, and information".[2]
- Time: money now is traded for money in the future.
- Uncertainty (or risk): The amount of money to be transferred in the future is uncertain.
- Options: one party to the transaction can make a decision at a later time that will affect subsequent transfers of money.
- Information: knowledge of the future can reduce, or possibly eliminate, the uncertainty associated with future monetary value (FMV).
A topic of general interest studied in recent years has been financial crises.[3]
The subject is usually taught at a postgraduate level; see Master of Financial Economics.
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Subject matter [edit]
Financial economics is the branch of economics studying the interrelation of financial variables, such as prices, interest rates and shares, as opposed to those concerning the real economy. Financial economics concentrates on influences of real economic variables on financial ones, in contrast to pure finance.
It studies the following:
- Valuation - Determination of the fair value of an asset
- How risky is the asset? (identification of the asset appropriate discount rate)
- What cash flows will it produce? (discounting of relevant cash flows)
- How does the market price compare to similar assets? (relative valuation)
- Are the cash flows dependent on some other asset or event? (derivatives, contingent claim valuation)
Financial econometrics is the branch of Financial Economics that uses econometric techniques to parameterise the relationships.
In the Journal of Economic Literature classification codes, Financial Economics is one of the 19 primary classifications, at JEL: G. It follows Monetary and International Economics and precedes Public Economics. Detailed subclassifications are linked in the following footnote.[4]
The New Palgrave Dictionary of Economics (2008, 2nd ed.) also uses the JEL codes to classify its entries in v. 8, Subject Index, including Financial Economics at pp. 863-64. The corresponding footnotes below have links to entry abstracts of The New Palgrave Online for each primary or secondary JEL category (10 or fewer per page, similar to Google searches):
- JEL: G – Financial Economics [5]
- JEL: G0 – General[6]
- JEL: G1 – General Financial Markets[7]
- JEL: G2 – Financial institutions and Services[8]
- JEL: G3 – Corporate finance and Governance[9]
Tertiary category entries can be also be searched.[10]
Models in financial economics [edit]
Financial economics is primarily concerned with building models to derive testable or policy implications from acceptble assumptions. Some fundamental ideas in financial economics are portfolio theory, the Capital Asset Pricing Model. Portfolio theory studies how investors should balance risk and return when investing in many assets or securities. The Capital Asset Pricing Model describes how markets should set the prices of assets in relation to how risky they are. The Modigliani-Miller Theorem describes conditions under which corporate financing decisions are irrelevant for value, and acts as a benchmark for evaluating the effects of factors outside the model that do affect value.
A common assumption is that financial decision makers act rationally (see Homo economicus; efficient market hypothesis). However, recently, researchers in experimental economics and experimental finance have challenged this assumption empirically. They are also challenged, theoretically, by behavioral finance, a discipline primarily concerned with the limits to rationality of economic agents.
Other common assumptions include market prices following a random walk or asset returns being normally distributed. Empirical evidence suggests that these assumptions may not hold and that in practice, traders, analysts and particularly risk managers frequently modify the "standard models".
See also [edit]
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- List of economics topics
- List of economists
- List of finance topics
- List of master's degrees in financial economics
- Deutsche Bank Prize in Financial Economics
References [edit]
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This article includes a list of references, but its sources remain unclear because it has insufficient inline citations. (October 2009) |
- ^ "Robert C. Merton - Nobel Lecture" (PDF). Retrieved 2009-08-06.
- ^ a b "Financial Economics". Stanford.edu. Retrieved 2009-08-06.
- ^ From The New Palgrave Dictionary of Economics, Online Editions, 2011, 2012, with abstract links:
• "regulatory responses to the financial crisis: an interim assessment" by Howard Davies
• "Credit Crunch Chronology: April 2007–September 2009" by The Statesman's Yearbook team
• "Minsky crisis" by L. Randall Wray
• "euro zone crisis 2010" by Daniel Gros and Cinzia Alcidi.
• Carmen M. Reinhart and Kenneth S. Rogoff, 2009. This Time Is Different: Eight Centuries of Financial Folly, Princeton. Description, ch. 1 ("Varieties of Crises and their Dates," pp. 3-20), and chapter-preview links. - ^ JEL classification codes — Financial economics JEL: G Subcategories
- ^ All entries under JEL: G: http://www.dictionaryofeconomics.com/search_results?,q=&field=content&edition=all&topicid=G
- ^ http://www.dictionaryofeconomics.com/search_results?q=&field=content&edition=all&topicid=G0
- ^ http://www.dictionaryofeconomics.com/search_results?q=&field=content&edition=all&topicid=G1
- ^ http://www.dictionaryofeconomics.com/search_results?q=&field=content&edition=all&topicid=G2
- ^ http://www.dictionaryofeconomics.com/search_results?q=&field=content&edition=all&topicid=G3
- ^ In particular by clicking to Advanced searches from http://www.dictionaryofeconomics.com/, which brings up http://www.dictionaryofeconomics.com/advanced_search, drilling to the secondary category, then to the tertiary category, followed by clicking the Search button at the bottom. For example, from secondary code JEL: G0, http://www.dictionaryofeconomics.com/search_results?,q=&field=content&edition=all&topicid=G0, then to the JEL: G00, then pressing the Search button to bring up the entry links at http://www.dictionaryofeconomics.com/search_results?q=&field=content&edition=all&topicid=G00.
External links [edit]
Theory [edit]
- Great Moments in Financial Economics I, II, "III". Archived from the original on 2007-09-27.; IVa; "IVb". Archived from the original on 2007-09-27.. Prof. Mark Rubinstein, Haas School of Business
- Microfoundations of Financial Economics Prof. André Farber Solvay Business School
- Handbook of the Economics of Finance, G.M. Constantinides, M. Harris, R. M. Stulz
- An introduction to investment theory, Prof. William Goetzmann, Yale School of Management
Context and history [edit]
- "A Short History of Investment Forecasting". Archived from the original on 2007-10-12., Professor Michael Phillips, California State University, Northridge
Links and portals [edit]
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