Theory of Incomplete Markets

Part 1 Introduction: main themes; bounded rationality, opportunism and structure of markets; rational expectations; the equilibrium model; real and financial sectors of the economy. Part 2 Two-period finance economy - motivation and summary: characteristics of the finance economy; contingent market equilibrium; financial market equilibrium; absence of arbitrage; no-arbitrage equilibrium; a basic property of incomplete markets; constrained pareto optimality; abstract approach - adjoint equations. Part 3 Two-period security pricing - motivation and summary: inner product, differential and gradient; valuation of income streams; representative agent analysis; capital asset pricing model (CAPM). Part 4 Stochastic financial economy - motivation and summary: event-tree commodity space; stochastic exchange economy; stochastic financial markets; absence of arbitrage; complete and incomplete markets; no-arbitrage equilibrium; example of non-existence; existence and optimality. Part 5 Information efficiency of security prices - motivation and summary: conditional expectation and martingale; efficient markets under risk neutrality; efficient markets with risk aversion. Part 6 Production in a finance economy - motivation and summary: characteristics of production economy; sole proprietorships; partnerships; corporations. Part 7 Monetary economy - motivation and summary: real and nominal contracts; monetary equilibrium; non-neutrality of monetary policy; optimal monetary policy; indexing contracts.