Preface <br>Ch. 1 On the Role of Financial Markets and Institutions 1 <br> Finance: The Time Dimension 1 <br> Desynchronization: The Risk Dimension 3 <br> The Screening and Monitoring Functions of the Financial System 4 <br> The Financial System and Economic Growth 5 <br> Financial Intermediation and the Business Cycle 8 <br> Financial Markets and Social Welfare 9 <br>App Introduction to General Equilibrium Theory 16 <br>Ch. 2 Making Choices in Risky Situations 21 <br> Choosing Among Risky Prospects: Preliminaries 21 <br> A Prerequisite: Choice Theory Under Certainty 25 <br> Choice Theory Under Uncertainty: An Introduction 26 <br> The Expected Utility Theorem 29 <br> How Restrictive Is Expected Utility Theory? The Allais Paradox 33 <br> Generalizing the VNM Expected Utility Representation 35 <br>Ch. 3 Measuring Risk and Risk Aversion 42 <br> Measuring Risk Aversion 42 <br> Interpreting the Measures of Risk Aversion 44 <br> Risk Premium and Certain Equivalence 47 <br> Assessing an Investor’s Level of Relative Risk Aversion 50 <br> The Concept of Stochastic Dominance 50 <br> Mean Preserving Spread 55 <br>App Proof of Theorem 3.2 58 <br>Ch. 4 Risk Aversion and Investment Decisions, Part I 59 <br> Risk Aversion and Portfolio Allocation: Risk Free Versus Risky Assets 59 <br> Portfolio Composition, Risk Aversion, and Wealth 61 <br> Special Case of Risk-Neutral Investors 64 <br> Risk Aversion and Risky Portfolio Composition 65 <br> Risk Aversion and Savings Behavior 66 <br> Separating Risk and Time Preferences 73 <br> Multiperiod Portfolio Choice 75 <br>Ch. 5 Risk Aversion and Investment Decisions, Part II: Modern Portfolio Theory 81 <br> More about Utility Functions 82 <br> Description of the Opportunity Set in the Mean-Variance Space: The Gains from Diversification and the Efficient Frontier 86 <br> The Optimal Portfolio: A Separation Theorem 91 <br>App. 5.1 Indifference Curves Under Quadratic Utility or Normally Distributed Returns 93 <br>App. 5.2 The Shape of the Efficient Frontier: Two Assets: Alternative Hypotheses 96 <br>App. 5.3 Constructing the Efficient Frontier 98 <br>Ch. 6 The Capital Asset Pricing Model: Another View About Risk 103 <br> The Traditional Approach to the CAPM 104 <br> The Mathematics of the Portfolio Frontier: Many Risky Assets and No Risk-Free Asset 107 <br> Characterizing Efficient Portfolios - (No Risk-Free Assets) 111 <br> Background for Deriving the Zero-Beta CAPM: Notion of a Zero Covariance Portfolio 113 <br> The Zero-Beta Capital Asset Pricing Model 115 <br> The Standard CAPM 116 <br>App. 6.1 Proof of the CAPM Relationship 121 <br>App. 6.2 The Mathematics of the Portfolio Frontier: An Example 122 <br>Ch. 7 Arrow-Debreu Pricing 124 <br> Setting: An Arrow-Debreu Economy 125 <br> Competitive Equilibrium and Pareto Optimality Illustrated 127 <br> Pareto Optimality and Risk Sharing 132 <br> Implementing Pareto Optimal Allocations: On the Possibility of Market Failure 135 <br> Market Completeness and Complex Securities 138 <br> Constructing State Contingent Claims Prices in a Risk-Free World: Deriving the Term Structure 140 <br> Forward Prices and Forward Rates 144 <br> The Value Additivity Theorem 145 <br>Ch. 8 Options and Market Completeness 148 <br> Using Options to Complete the Market: An Abstract Setting 149 <br> Synthesizing State-Contingent Claims: A First Approximation 153 <br> Recovering Arrow-Debreu Prices from Options Prices: A Generalization 155 <br> Arrow-Debreu Pricing in a Multiperiod Setting 160 <br>App Review of Basic Options, Concepts, and Terminology 166 <br>Ch. 9 The Martingale Measure in Discrete Time, Part I 172 <br> The Setting and the Intuition 174 <br> Notation, Definitions, and Basic Results 175 <br> Uniqueness 180 <br> Incompleteness 182 <br> Equilibrium and No Arbitrage Condition 184 <br> Application: Maximizing the Expected Utility of Terminal Wealth 186 <br>App. 9.1 CAPM-Based Certainty Equivalents 192 <br>App. 9.2 Finding the Stock and Bond Economy That Is Directly Analogous to the Arrow-Debreu Economy in Which Only State Claims Are Traded 193 <br>App. 9.3 Proof of the Second Part of Proposition 9.6 195 <br>Ch. 10 The Consumption Capital Asset Pricing Model (CCAPM) 196 <br> The Representative Agent Hypothesis and Its Notion of Equilibrium 196 <br> An Exchange (Endowment) Economy 199 <br> Pricing Arrow-Debreu State-Contingent Claims with the CCAPM 206 <br> Testing the Consumption CAPM: The Equity Premium Puzzle 209 <br> Testing the Consumption CAPM: Hansen-Jagannathan Bounds 213 <br> Some Extensions 215 <br>App. 10.1 Solving the CCAPM with Growth 222 <br>App. 10.2 Some Properties of the Lognormal Distribution 223 <br>Ch. 11 The Martingale Measure in Discrete Time, Part II 224 <br> Discrete Time Infinite Horizon Economies: A CCAPM Setting 224 <br> Risk-Neutral Pricing in the CCAPM 226 <br> The Binominal Model of Derivatives Valuation 231 <br> Continuous Time: An Introduction to the Black-Scholes Formula 240 <br> Dybvig’s Evaluation of Dynamic Trading Strategies 242 <br>App. 11.1 Risk-Neutral Valuation When Discounting at the Term Structure 246 <br>App. 11.2 An Intuitive Overview of Continuous Time Finance 247 <br>Ch. 12 The Arbitrage Pricing Theory 261 <br> Factor Models 262 <br> The APT: Statement and Proof 264 <br> Multifactor Models and the APT 266 <br> Advantage of the APT for Stock or Portfolio Selection 268 <br>Ch. 13 Financial Structure and Firm Valuation in Incomplete Markets 270 <br> Financial Structure and Firm Valuation 271 <br> Arrow-Debreu and Modigliani-Miller 276 <br> On the Role of Short Selling 278 <br> Financing and Growth 279 <br>App Details of the Solution of the Contingent Claims Trade Case of Section 13.5 285 <br>Ch. 14 Financial Equilibrium with Differential Information 287 <br> On the Possibility of an Upward Sloping Demand Curve 289 <br> An Illustration of the Concept of REE: Homogeneous Information 290 <br> Fully Revealing REE: An Example 294 <br> The Efficient Market Hypothesis 297 <br>App Bayesian Updating with the Normal Distribution 300 <br>Exercises 301 <br>Index 321 <br>