Teaching
Introduction to Financial Markets BUS 351
Syllabus Short Description
Futures market price quotes and transaction prices are derived endogenously in an artificial market with bilateral trading via a continuous double auction. The market participants have different strategies and reasons for trading futures. Hedgers, speculators and scalpers, with heterogeneous expectations, produce a bid-ask spread and mid-price from bilateral exchange that converges to the theoretical Walrasian price and is always mean reverting. Risk neutral speculators try to maximize profit, while being bound by margin requirements, trading costs and real time gross settlement. We find that the bid-ask spread can be derived without market makers, and speculators compete with each other reducing the spread to their cost of transacting. Trading opportunities, or market liquidity, increases when margins and taxes are low. The amount of trading declines when margins and taxes are high, however prices appear to be more efficient as trading volatility is less. Raising transaction costs increases the number of limit orders from speculators and this in turn helps stabilize the market. Scalpers who enter the market make a profit by offering immediacy, and thereby liquidity. However scalpers can increase trading volatility by supplying liquidity to destabilizing speculators who are called on to make margin calls.
Class Experiment for BUS351 2006 -
The Asset market bubble experiment
Module for the Teaching Innovations Program (TIP) in Economics
In 2006 the class incorporated an online experiment, offered by the Experimental Economics Center at Georgia State University, http://econport.org, and follows experiments by Smith, Suchanek, and Williams (1988). Under rational expectations, the known probability of the future dividend returns allows all agents to calculate the expected market price of the stock, and the market would jump to this price with no trade. This rarely happens with student traders and thus, this experience allows for an understanding of important concepts in finance: rational expectations and the no-trade model, smart versus uninformed traders, efficient markets, liquidity, risk aversion, the continuous double auction, and the limit-order book. This experiment will need to be run several times (e.g. outside of class time) for students to fully appreciate this model. Students were asked to analyze the limit order book for one run where a stock market bubble emerged, using Miller (2002). In addition, students were given 9 short answer questions. Study of the limit order book allowed for a surprisingly productive way for students to understand the difficult financial concepts mentioned above. More details can be found in the TIP report
References:
Smith, Vernon L., Gerry L. Suchanek, and Arlington W. Williams (1988). "Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets," Econometrica, 56:5, pp. 1119-1151.
Ross Miller (2002) Experimental Economics: How We Can Build Better Financial Markets. John Wiley & Sons.
Introduction to Futures and Options BUS 353
Syllabus Short Description
The creation and trading of derivatives on an exchange is examined. Emphasis is placed on how options and futures can be used for speculation, hedging and arbitrage. Students will learn the reasons for participation in this market, and distinguish the impact between speculation and arbitrage, and their impact on market prices. Most class time will focus on solving for equilibrium prices and learning price parity theorems. These theorems and their assumptions make this course highly technical. Through artificial trading students will get the chance to implement conceptual tools such as profit and loss diagrams, option trading strategies, binominal trees , option greeks, and the Black-Scholes formula. Students will learn how to minimize risk with futures through immunization, asset allocation, and duration matching. Some elements of financial engineering will also be presented, if time allows.
Prerequisite
Math 131, Statistics ECON 249, Corporate Finance BUS 241 and Investment Analysis BUS 350 must have already been taken with a passing grade. Students who have not taken this course will be dropped from the class. You are expected to be facile with basic calculus, statistics and financial concepts. If you are unsure on discounting cashflows, calculating returns, risk return trade-offs, and basic statistics (mean, variance, covariance, correlations, and random variables) then please review this material.
