Book description
Targeting readers with backgrounds in economics, Intermediate Financial Theory, Third Edition includes new material on the asset pricing implications of behavioral finance perspectives, recent developments in portfolio choice, derivativesrisk neutral pricing research, and implications of the 2008 financial crisis. Each chapter concludes with questions, and for the first time a freely accessible website presents complementary and supplementary material for every chapter. Known for its rigor and intuition, Intermediate Financial Theory is perfect for those who need basic training in financial theory and those looking for a userfriendly introduction to advanced theory.
 Completely updated edition of classic textbook that fills a gap between MBA and PhDlevel texts
 Focuses on clear explanations of key concepts and requires limited mathematical prerequisites
 Online solutions manual available
 Updates include new structure emphasizing the distinction between the equilibrium and the arbitrage perspectives on valuation and pricing, and a new chapter on asset management for the longterm investor
Table of contents
 Cover image
 Title page
 Copyright
 Preface
 Epigraph
 Dedication

Part I: Introduction

Chapter 1. On the Role of Financial Markets and Institutions
 1.1 Finance: The Time Dimension
 1.2 Desynchronization: The Risk Dimension
 1.3 The Screening and Monitoring Functions of the Financial System
 1.4 The Financial System and Economic Growth
 1.5 Financial Markets and Social Welfare
 1.6 Financial Intermediation and the Business Cycle
 1.7 Financial Crises
 1.8 Conclusion
 References
 Complementary Readings
 Appendix: Introduction to General Equilibrium Theory
 Chapter 2. The Challenges of Asset Pricing: A Road Map

Chapter 1. On the Role of Financial Markets and Institutions

Part II: The Demand for Financial Assets

Chapter 3. Making Choices in Risky Situations
 3.1 Introduction
 3.2 Choosing Among Risky Prospects: Preliminaries
 3.3 A Prerequisite: Choice Theory Under Certainty
 3.4 Choice Theory Under Uncertainty: An Introduction
 3.5 The Expected Utility Theorem
 3.6 How Restrictive Is Expected Utility Theory? The Allais Paradox
 3.7 Behavioral Finance
 3.8 Conclusions
 References

Chapter 4. Measuring Risk and Risk Aversion
 4.1 Introduction
 4.2 Measuring Risk Aversion
 4.3 Interpreting the Measures of Risk Aversion
 4.4 Risk Premium and Certainty Equivalence
 4.5 Assessing the Degree of Relative Risk Aversion
 4.6 The Concept of Stochastic Dominance
 4.7 Mean Preserving Spreads
 4.8 An Unsettling Observation About Expected Utility
 4.9 Applications: Leverage and Risk
 4.10 Conclusions
 References
 Appendix: Proof of Theorem 4.2

Chapter 5. Risk Aversion and Investment Decisions, Part 1
 5.1 Introduction
 5.2 Risk Aversion and Portfolio Allocation: RiskFree Versus Risky Assets
 5.3 Portfolio Composition, Risk Aversion, and Wealth
 5.4 Special Case of RiskNeutral Investors
 5.5 Risk Aversion and Risky Portfolio Composition
 5.6 Risk Aversion and Savings Behavior
 5.7 Generalizing the VNMExpected Utility Representation
 5.8 Conclusions
 References

Chapter 6. Risk Aversion and Investment Decisions, Part II: Modern Portfolio Theory
 6.1 Introduction
 6.2 More About Utility Functions and Return Distributions
 6.3 Refining the NormalityofReturns Assumption
 6.4 Description of the Opportunity Set in the Mean–Variance Space: The Gains from Diversification and the Efficient Frontier
 6.5 The Optimal Portfolio: A Separation Theorem
 6.6 Stochastic Dominance and Diversification
 6.7 Conclusions
 References
 Appendix 6.1: Indifference Curves Under Quadratic Utility or Normally Distributed Returns
 Appendix 6.2: The Shape of the Efficient Frontier; Two Assets; Alternative Hypotheses
 Appendix 6.3: Constructing the Efficient Frontier
 Chapter 7. Risk Aversion and Investment Decisions, Part III: Challenges to Implementation

Chapter 3. Making Choices in Risky Situations

Part III: Equilibrium Pricing

Chapter 8. The Capital Asset Pricing Model
 8.1 Introduction
 8.2 The Traditional Approach to the CAPM
 8.3 Valuing Risky Cash Flows with the CAPM
 8.4 The Mathematics of the Portfolio Frontier: Many Risky Assets and No RiskFree Asset
 8.5 Characterizing Efficient Portfolios (No RiskFree Assets)
 8.6 Background for Deriving the ZeroBeta CAPM: Notion of a ZeroCovariance Portfolio
 8.7 The ZeroBeta CAPM
 8.8 The Standard CAPM
 8.9 An Empirical Assessment of the CAPM
 8.10 Conclusions
 References
 Appendix 8.1: Proof of the CAPM Relationship
 Appendix 8.2: The Mathematics of the Portfolio Frontier: An Example
 Appendix 8.3: Diagrammatic Representation of the Fama–MacBeth TwoStep Procedure
 Chapter 9. Arrow–Debreu Pricing, Part I

Chapter 10. The Consumption Capital Asset Pricing Model
 10.1 Introduction
 10.2 The Representative Agent Hypothesis and its Notion of Equilibrium
 10.3 An Exchange (Endowment) Economy
 10.4 Pricing Arrow–Debreu StateContingent Claims with the CCAPM
 10.5 Testing the CCAPM: The Equity Premium Puzzle
 10.6 Testing the CCAPM: Hansen–Jagannathan Bounds
 10.7 The SDF in Greater Generality
 10.8 Some Extensions
 10.9 Conclusions
 References
 Appendix 10.1 Solving the CCAPM with Growth
 Appendix 10.2 Some Properties of the Lognormal Distribution

Chapter 8. The Capital Asset Pricing Model

Part IV: Arbitrage Pricing

Chapter 11. Arrow–Debreu Pricing, Part II
 11.1 Introduction
 11.2 Market Completeness and Complex Securities
 11.3 Constructing StateContingent Claims Prices in a RiskFree World: Deriving the Term Structure
 11.4 The Value Additivity Theorem
 11.5 Using Options to Complete the Market: An Abstract Setting
 11.6 Synthesizing StateContingent Claims: A First Approximation
 11.7 Recovering Arrow–Debreu Prices from Options Prices: A Generalization
 11.8 Arrow–Debreu Pricing in a Multiperiod Setting
 11.9 Conclusions
 References
 Appendix 11.1: Forward Prices and Forward Rates

Chapter 12. The Martingale Measure: Part I
 12.1 Introduction
 12.2 The Setting and the Intuition
 12.3 Notation, Definitions, and Basic Results
 12.4 Uniqueness
 12.5 Incompleteness
 12.6 Equilibrium and No Arbitrage Opportunities
 12.7 Application: Maximizing the Expected Utility of Terminal Wealth
 12.8 Conclusions
 References
 Appendix 12.1 Finding the Stock and Bond Economy That Is Directly Analogous to the Arrow–Debreu Economy in Which Only State Claims Are Traded
 Appendix 12.2 Proof of the Second Part of Proposition 12.6

Chapter 13. The Martingale Measure: Part II
 13.1 Introduction
 13.2 Discrete Time Infinite Horizon Economies: A CCAPM Setting
 13.3 RiskNeutral Pricing in the CCAPM
 13.4 The Binomial Model of Derivatives Valuation
 13.5 Continuous Time: An Introduction to the Black–Scholes Formula
 13.6 Dybvig’s Evaluation of Dynamic Trading Strategies
 13.7 Conclusions
 References
 Appendix 13.1: RiskNeutral Valuation When Discounting at the Term Structure of Multiperiod Discount Bond

Chapter 14. The Arbitrage Pricing Theory
 14.1 Introduction
 14.2 Factor Models: A First Illustration
 14.3 A Second Illustration: Multifactor Models, and the CAPM
 14.4 The APT: A Formal Statement
 14.5 Macroeconomic Factor Models
 14.6 Models with FactorMimicking Portfolios
 14.7 Advantage of the APT for Stock or Portfolio Selection
 14.8 Conclusions
 References
 Appendix A.14.1: A Graphical Interpretation of the APT
 Appendix 14.2: Capital Budgeting

Chapter 15. An Intuitive Overview of Continuous Time Finance
 15.1 Introduction
 15.2 Random Walks and Brownian Motion
 15.3 More General Continuous Time Processes
 15.4 A Continuous Time Model of Stock Price Behavior
 15.5 Simulation and European Call Pricing
 15.6 Solving Stochastic Differential Equations: A First Approach
 15.7 A Second Approach: Martingale Methods
 15.8 Applications
 15.9 Final Comments
 References
 Chapter 16. Portfolio Management in the Long Run
 Chapter 17. Financial Structure and Firm Valuation in Incomplete Markets
 Chapter 18. Financial Equilibrium with Differential Information

Chapter 11. Arrow–Debreu Pricing, Part II
 Index
 List of Frequently Used Symbols and Notation
Product information
 Title: Intermediate Financial Theory, 3rd Edition
 Author(s):
 Release date: October 2014
 Publisher(s): Academic Press
 ISBN: 9780123868718
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