Financial decision theory (FIN)

(mars 2022)

Financial Decision Theory teaches classical economic and financial applications of decision theory under risk and uncertainty. The first part of the course reviews the basic tools from expected utility under risk and uncertainty. The second part introduces students to theories of ambiguity (Knightian uncertainty). The third part is really the core of the course and focuses on applications to portfolio choice, demand for insurance, savings behavior, optimal risk sharing in financial markets.

The program is as follows :

1. Expected utility under risk and uncertainty: (comparative) risk aversion, risk premium, coefficients of risk aversion, prudence, stochastic dominance, etc.
2. Ambiguity theory: Ellsberg paradox. Introduction to Choquet Expected Utility and Maxmin Expected Utility.
3. Financial applications: (a) the role of risk aversion in portfolio choice/demand for insurance, (b) the role of prudence in the formation of precautionary savings, (c) the role of heterogeneity in belief in the emergence of speculative trade among risk averse investors, (d) ambiguity as an explanation for several empirical "anomalies" (equity premium puzzle, portfolio inertia, absence of trade, etc.)

Students are evaluated on the basis of a written exam and a group project that allows them to either deepen the notions discussed in class or learn new economic and financial applications of decision theory.

References : Economics of Risk and Time. Christian Gollier. 2004. MIT Press.