See link below:
Two Nobel laureates in economics from the University of Chicago, Eugene Fama (2013) and Richard Thaler (2017) debate the efficient market hypothesis. This debate is required viewing for anyone with even a remote interest in finance! (spoiler alert – virtually all derivatives pricing models covered in Finance 4366 assume that the underlying asset follows a random walk, which corresponds to the so-called “weak form” of Fama’s efficient market hypothesis)…
Eugene F. Fama and Richard H. Thaler discuss whether markets are prone to bubbles.
An ongoing debate in finance is whether “active” investment strategies can outperform “passive” strategies. The empirical evidence in favor of passive strategies which appears in studies published by peer-reviewed scientific journals is overwhelming. For example, in studies of mutual fund performance, passive strategies almost always blow away active strategies. Similarly, the empirical evidence on frequency of trading by “retail” customers is that on average, portfolio performance is inversely related to trading frequency; i.e., the more people trade, the worse they do. Even hedge funds chronically underperform passive investment strategies. For example, the authors of a 2011 Journal of Financial Economics (JFE) article entitled “Higher risk, lower returns: What hedge fund investors really earn” find that hedge fund returns are on the magnitude of 3% to 7% lower than corresponding buy-and-hold fund returns, reliably lower than the return on the Standard & Poor’s (S&P) 500 index, and only marginally higher than the riskless rate of interest.
I have decided to offer the following extra credit opportunity for Finance 4366. You can earn extra credit by attending and reporting on Dr. P. J. Hill’s upcoming lecture entitled “Saving the Environment Through Prices and Property Rights”:
If you decide to take advantage of this opportunity, I will use the grade you earn to replace your lowest quiz grade in Finance 4366 (assuming that your grade on the extra credit is higher than your lowest quiz grade). The report should be in the form of a 1-2 page executive summary in which you provide a critical analysis of Dr. Hill’s lecture. In order to receive credit, the report must be submitted via email to firstname.lastname@example.org in either Word or PDF format by no later than Monday, March 26 at 5 p.m.
… are available at http://fin4366.garven.com/spring2018/ps7solutions.pdf.
Linked below are the solutions for the problem set that we worked on during class today!
Perhaps a “trigger” warning is in order concerning next Tuesday’s meeting of Finance 4366. Since we’ll be covering the topic of Ito’s Lemma, it will be a bit on the “mathy” side. We will introduce Ito’s Lemma and use it to accomplish (among other things) the following tasks: 1) derive the parameters of the probability distribution for continuously compounded rates of return, and 2) determine the stochastic process for forward contracts. Our class meeting tomorrow will begin with a quiz based upon the assigned readings, which include Hull’s textbook chapter entitled “Wiener Processes and Ito’s Lemma” and my teaching notes entitled “Applying Ito’s Lemma to determine the parameters of the probability distribution for the continuously compounded rate of return” and “Geometric Brownian Motion Simulations“.
Problem set 7 is due on Tuesday, March 20; it is the second of two problem sets assigned for the Binomial Trees topic which we completed during today’s meeting of Finance 4366.
Problem 4 on this problem set requires applying the Cox-Ross-Rubinstein framework to determine the current market value of a six-month European call option, assuming that the number of time-steps (n) is equal to 15. For what it’s worth, the Cox-Ross-Rubinstein framework is succinctly summarized in my teaching note entitled “Convergence of the Cox-Ross-Rubinstein (CRR) Binomial Option and Black-Scholes-Merton (BSM) Option Pricing Formulas”.
As we segue from discrete-time to continuous time pricing models in Finance 4366, you will surely find this topic to be quite challenging. But it is essential, since a basic understanding of the continuous time framework is, as Hull puts it, “central to the pricing of derivatives”. As you read the readings assigned for Tuesday, March 20 (consisting of Hull’s textbook chapter entitled “Wiener Processes and Ito’s Lemma” and my teaching notes entitled “Applying Ito’s Lemma to determine the parameters of the probability distribution for the continuously compounded rate of return” and “Geometric Brownian Motion Simulations“), keep the following exhortation by Hull in mind (this appears as the third paragraph on the first page of the textbook chapter assigned for next Tuesday):
“Many people feel that continuous-time stochastic processes are so complicated that they should be left entirely to ‘‘rocket scientists.’’ This is not so. The biggest hurdle to understanding these processes is the notation. Here we present a step-by-step approach aimed at getting the reader over this hurdle. We also explain an important result known as Ito’s lemma that is central to the pricing of derivatives.”