Financial economics

Financial economics is the branch of economics concerned with resource allocation over time. The questions addressed are typically framed in terms of "time, uncertainty, options and information" [1].

• 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).

Financial economics is also distinguished from other branches of economics 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 discipline thus deals with the workings of financial markets, such as the stock market, and the financing of companies, and includes the following subject areas: Budgeting, saving, investing, borrowing, lending, insuring, hedging, diversifying, and asset management. Because the future is never known with certainty, a central concern of financial economics is the impact of uncertainty on resource allocation. Financial economics thus attempts to answer questions such as:

• How are the prices of financial assets determined (stocks, bonds, currencies, and commodities)?
• What are the effects of a company choosing different methods of financing its operations, such as issuing shares or borrowing?
• What portfolio of assets should an investor hold in order to best meet his/her objectives?

Financial economics is based on several assumptions - chief amongst these, that financial decision makers are rational (see Homo economicus). However, recently, researchers in Experimental economics and Experimental finance have challenged this assumption empirically. Further, these assumptions are challenged - theoretically - by Behavioral finance, a discipline primarily concerned with the rationality, or lack thereof, of economic agents.

Important concepts

• Risk-free interest rate
• Time value of money
• Fisher separation theorem
• Modigliani-Miller theorem
• Arbitrage
• Rational pricing
• Efficient market theory
• Modern portfolio theory
• Yield curve
• Homo economicus
• Arrow-Debreu model

Finance journals

• Journal of Finance
• Review of Financial Studies
• Journal of Financial Economics
• Econometrica
• Financial Analysts Journal
• Journal of Investment Management

See also

• Finance
• Value investing
• Financial mathematics
• Financial engineering
• Mathematical economics
• Model (economics)
• Experimental economics
• Experimental finance
• Behavioral finance
• Bank of Sweden Prize in Economic Sciences

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External links and references

Theory

• "Macro-Investment Analysis", Professor William Sharpe, Stanford Graduate School of Business
• Lecture Notes in Financial Economics, Antonio Mele, London School of Economics
• Great Moments in Financial Economics I, II, III, Prof. Mark Rubinstein, Haas School of Business

General

• Finance Theory, The History of Economic Thought Website, The New School
• Great Ideas in Finance, riskmetrics.com
• Fallacies of Financial Economics, John Oswin Schroy, capital-flow-analysis.com

• A Short History of Investment Forecasting, Professor Michael Phillips, California State University, Northridge
• Pioneers of Finance, Prof. Larry Guin, Murray State University
• How Modern is Modern Portfolio Theory?, Peter L. Bernstein

Institutions

• Yale International Center for Finance at the Yale School of Management
• Quantitative Finance Research Centre at the University of Technology, Sydney

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