(ECON 252) Financial institutions are a pillar of civilized society, supporting people in their productive ventures and managing the economic risks they take on. The workings of these institutions are important to comprehend if we are to predict their actions today and their evolution in the coming information age. The course strives to offer understanding of the theory of finance and its relation to the history, strengths and imperfections of such institutions as banking, insurance, securities, futures, and other derivatives markets, and the future of these institutions over the next century.
This course was recorded in Spring 2008.
01 - Finance and Insurance as Powerful Forces in Our Economy and Society
Professor Shiller provides a description of the course, Financial Markets, including administrative details and the topics to be discussed in each lecture. He briefly discusses the importance of studying finance and each key topic. Lecture topics will include: behavioral finance, financial technology, financial instruments, commercial banking, investment banking, financial markets and institutions, real estate, regulation, monetary policy, and democratization of finance.
02 - The Universal Principle of Risk Management: Pooling and the Hedging of Risks
Statistics and mathematics underlie the theories of finance. Probability Theory and various distribution types are important to understanding finance. Risk management, for instance, depends on tools such as variance, standard deviation, correlation, and regression analysis. Financial analysis methods such as present values and valuing streams of payments are fundamental to understanding the time value of money and have been in practice for centuries.
03 - Technology and Invention in Finance
Technology and innovation underlie finance. In order to manage risks successfully, particularly long-term, we must pool large amounts of risk among many, diverse people and overcome barriers such as moral hazard and erroneous framing. Inventions such as insurance contracts and social security, and information technology all the way from such simple things as paper, and the postal service to modern computers have helped to manage risks and to encourage financial systems to address issues pertaining to risk. The tax and welfare system is one of the most important risk management systems.
04 - Portfolio Diversification and Supporting Financial Institutions (CAPM Model)
Portfolio diversification is the most fundamental concept of risk management. The allocation of financial resources in stocks, bonds, riskless, assets, oil and other assets determine the expected return and risk of a portfolio. Taking account of covariances and expected returns, investors can create a diversified portfolio that maximizes expected return for a given level of risk. An important mission of financial institutions is to provide portfolio-diversification services.
05 - Insurance: The Archetypal Risk Management Institution
Insurance provides significant risk management to a broad public, and is an essential tool for promoting human welfare. By pooling large numbers of independent or low-correlated risks, insurance providers can minimize overall risk. The risk management is tailored to individual circumstances and reflects centuries of insurance industry experience with real risks and with moral hazard and selection bias issues. Probability theory and statistical tools help to explain how insurance companies use risk pooling to minimize overall risk. Innovation and government regulation have played important roles in the formation and oversight of insurance institutions.
06 - Efficient Markets vs. Excess Volatility
Several theories in finance relate to stock price analysis and prediction. The efficient markets hypothesis states that stock prices for publicly-traded companies reflect all available information. Prices adjust to new information instantaneously, so it is impossible to "beat the market." Furthermore, the random walk theory asserts that changes in stock prices arise only from unanticipated new information, and so it is impossible to predict the direction of stock prices. Using statistical tools, we can attempt to test the hypotheses and to predict future stock prices. These tests show that efficient markets theory is a half-truth: it is difficult but not impossible for some people to beat the market.