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# Intermediate Financial Theory

- 3rd Edition - September 25, 2014
- Authors: Jean-Pierre Danthine, John B. Donaldson
- Language: English
- Hardback ISBN:9 7 8 - 0 - 1 2 - 3 8 6 5 4 9 - 6
- eBook ISBN:9 7 8 - 0 - 1 2 - 3 8 6 8 7 1 - 8

Targeting readers with backgrounds in economics, Intermediate Financial Theory, Third Edition includes new material on the asset pricing implications of behavioral finance p… Read more

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## Institutional subscription on ScienceDirect

Request a sales quoteTargeting 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, derivatives-risk 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 user-friendly introduction to advanced theory.

- Completely updated edition of classic textbook that fills a gap between MBA- and PhD-level 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 long-term investor

- 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
- 2.1 The Main Question of Financial Theory
- 2.2 Discounting Risky Cash Flows: Various Lines of Attack
- 2.3 Two Main Perspectives: Equilibrium versus Arbitrage
- 2.4 Decomposing Risk Premia
- 2.5 Models and Stylized Facts
- 2.6 Asset Pricing Is Not All of Finance!
- 2.7 Banks
- 2.8 Conclusions
- References

- 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: Risk-Free Versus Risky Assets
- 5.3 Portfolio Composition, Risk Aversion, and Wealth
- 5.4 Special Case of Risk-Neutral Investors
- 5.5 Risk Aversion and Risky Portfolio Composition
- 5.6 Risk Aversion and Savings Behavior
- 5.7 Generalizing the VNM-Expected 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 Normality-of-Returns 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
- 7.1 Introduction
- 7.2 The Consequences of Parameter Uncertainty
- 7.3 Trends and Cycles in Stock Market Return Data
- 7.4 Equally Weighted Portfolios
- 7.5 Are Stocks Less Risky for Long Investment Horizons?
- 7.6 Conclusions
- References
- Appendix 7.1

- 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 Risk-Free Asset
- 8.5 Characterizing Efficient Portfolios (No Risk-Free Assets)
- 8.6 Background for Deriving the Zero-Beta CAPM: Notion of a Zero-Covariance Portfolio
- 8.7 The Zero-Beta 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 Two-Step Procedure

- Chapter 9. Arrow–Debreu Pricing, Part I
- 9.1 Introduction
- 9.2 Setting: An Arrow–Debreu Economy
- 9.3 Competitive Equilibrium and Pareto Optimality Illustrated
- 9.4 Pareto Optimality and Risk Sharing
- 9.5 Implementing PO Allocations: On the Possibility of Market Failure
- 9.6 Risk-Neutral Valuations
- 9.7 Conclusions
- References

- 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 State-Contingent 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 State-Contingent Claims Prices in a Risk-Free 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 State-Contingent 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 Risk-Neutral 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: Risk-Neutral 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 Factor-Mimicking 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
- 16.1 Introduction
- 16.2 The Myopic Solution
- 16.3 Variations in the Risk-Free Rate
- 16.4 The Long-Run Behavior of Stock Returns
- 16.5 Background Risk: The Implications of Labor Income for Portfolio Choice
- 16.6 An Important Caveat
- 16.7 Another Background Risk: Real Estate
- 16.8 Conclusions
- References

- Chapter 17. Financial Structure and Firm Valuation in Incomplete Markets
- 17.1 Introduction
- 17.2 Financial Structure and Firm Valuation
- 17.3 Arrow–Debreu and Modigliani–Miller
- 17.4 On the Role of Short Selling
- 17.5 Financing and Growth
- 17.6 Conclusions
- References
- Appendix Details of the Solution of the Contingent Claims Trade Case of Section 17.5

- Chapter 18. Financial Equilibrium with Differential Information
- 18.1 Introduction
- 18.2 On the Possibility of an Upward-Sloping Demand Curve
- 18.3 An Illustration of the Concept of REE: Homogeneous Information
- 18.4 Fully Revealing REE: An Example
- 18.5 The Efficient Market Hypothesis
- References
- Appendix Bayesian Updating with the Normal Distribution

- Chapter 11. Arrow–Debreu Pricing, Part II
- Index
- List of Frequently Used Symbols and Notation
- Roman Alphabet
- Greek Alphabet
- Numerals and Other Terms

- No. of pages: 580
- Language: English
- Edition: 3
- Published: September 25, 2014
- Imprint: Academic Press
- Hardback ISBN: 9780123865496
- eBook ISBN: 9780123868718

JD

### Jean-Pierre Danthine

JD