http://www.econ.duke.edu/~get/browse/courses/200/fall01/200f01.htm

Professor Tauchen, 221 Social Science

Office Hours: 9:30 AM - 11:00AM Monday and Wednesday

NEWS: Course news on line

PROJECTS: Assignments

HANDOUTS: Most, but not all of the materials handed out in class.  Many are in .pdf format, which can be viewed and printed using Adobe Acrobat Reader

Outlines from previous years: 1998, 1999, 2000

Background: The course will use tools and techniques developed in Economics 149, 154, 157 (or 158), and Statistics 110 to study models of financial derivatives. A financial derivative, such as a stock option, is a security whose returns are contractually related to the returns of another security or group of securities. Although stock options have been traded for hundreds of years, the general use of derivatives has grown dramatically since the early 1970s. Indeed, the volume of trading on organized options markets has, at times, exceeded that of the New York Stock Exchange. The types of traded derivatives has now expanded to include a vast array of financial instruments including options on broad stock market indexes, futures on stock indexes, futures on U.S. Treasury securities, fixed for variable interest rate swaps, and even more exotic options. A completely satisfactory theory of option valuation was not developed until the early 1970s. Since that time, the theory has been extended and refined to include complex exotic derivatives.

Procedures: This course is a seminar course that requires substantial student involvement with the material and the numerical work. It is not a traditional lecture/exam type course. In the first half of the course, I will give lectures on the various models and techniques available for derivatives pricing. Students will develop and execute numerical work on research projects during this portion of the course. In the second half of the course, students will give presentations to the group on the results of their research projects. Thus, only students who are interested in learning in this intensive hands-on manner should register for the course. Students expecting a course on financial engineering taught in the traditional lecture format should not register for the course.

Objectives: Students will learn to implement the essential tools and techniques of derivatives pricing including the Black-Scholes formula for basic options, the Cox-Ingersoll-Ross model for fixed income analysis, and the binomial model for more complex derivatives. Extensive use will be made of spreadsheets and computer software packages, and perhaps interactive mathematical packages as sophisticated as MATLAB. Students will be expected to prepare and document at least four projects, with two of the projects summarized in a formal extensive research paper. Students will also be expected to give presentations of work in progress and to participate in in-class workshop presentations of work in progress. Expectations are high in terms of level of student participation and involvement with the course material.

Topics: Futures, both financial and commodity; European and American call and put options; Black-Scholes valuation; binomial models; term structure of interest rates; fixed income securities; interest rate and currency swaps.

Prerequisites: Economics 149, Economics 154, Statistics (STA 110 B preferred), and Economics 157 (or 158). Economics 154 and Economics 157 or 158 may be taken concurrently with the consent of the instructor. Additional coursework in computer science and mathematics is helpful but not essential.

Grade: Final grade is based on the four projects, two of which are to be developed into a longer research paper, and together count 80%; attendance, classroom interest, and general level of enthusiasm count the remaining 20%.

 Warnings: Finance, and in particular financial engineering, is inherently a technical and analytical field. The 1997 Nobel Prize in Economics was awarded to two finance professors for the derivation of a complicated, but very widely used formula for pricing derivative securities. (The derivation of the formula involved the solution of a complicated partial differential equation!) We will study aspects of that formula (not the partial differential equation) in this course. Be forewarned about the nature of the subject matter, the prerequisites, and the level of student involvement expected.
 
 

Books and Reading Materials (* denotes required):

http://finance.yahoo.com, http://chart.yahoo.com/d: Excellent sources for historical financial data.

http://www.afajof.org/: Journal of Finance home page.

http://www.cob.ohio-state.edu/~fin/journal/jofsites.htm#edres links to many other useful finance related materials on the web prepared by the Journal of Finance.

http://www.duke.edu/~charveyThis site is the web page of Cam Harvey, Professor of Finance, Fuqua School of Business, Duke University. It is among the top ten rated web pages in finance.

 http://nber.org National Bureau of Economic Research. Links to many useful economics web sites along with useful historical statistics.

http://www.econ-datalinks.org Web site of the Business and Economic Statistics Section of the ASA. It contains links to many useful data sources for economics and business.

http://www.finweb.com This site is a comprehensive set of links to many useful sites in finance.

http://www.jpmorgan.com This site is the J. P. Morgan site. Nearly all major investment banks and financial firms have useful web sites.

http://www.nyse.com
http://www.cbot.com
http://www.cme.com
These are the web sites of the New York Stock Exchange, the Chicago Board of Trade, and the Chicago Mercantile Exchange. Most other major exchanges have useful web sites as well.
 
 

Overview of Derivative Securities