Financial Economics

1

INTRODUCTION

This book presents the foundations of financial economics, a specialized area within economics that utilizes many of the analytical tools developed in the field of microeconomics. Common to both financial economics and microeconomics is a theoretical framework for analyzing the decisions by individuals and managers of firms, and also the interplay of these decisions on the prices of financial assets. In studying these decisions, both fields look at the allocation of limited resources to optimize some measure, with the optimization subject to some constraints. In fact, because of the commonality of topics and tools in the chapters of this book, some consider financial economics a specialized area within microeconomics rather than as a separate branch of economics.

In this chapter, we provide a broad overview of the major types of decisions with which the field of financial economics is concerned. We begin this chapter with the decisions made by individuals and managers, along with the role of markets in which these agents transact. These decisions fall into the area of microeconomics. Then we look at the same kinds of decisions and markets that fall under the purview of financial economics.

1.1 MICROECONOMIC THEORY: INDIVIDUALS, MANAGERS, AND MARKETS

Microeconomic theory provides a theoretical framework for analyzing the economic behavior of individuals who are regarded either as consumers of products or as managers of firms. Let's look at the types of decisions these ...