KFIN 2655A – 16243

Decision under Risk

Sciences Po, M2, Finance and Strategy and M2, Financial Regulation and Risk Management
Winter 2013 (24h)

Course material

 

The course material is available here.

The institutional web page of the course is here.

Final exam’s grade statistics:

min	8,4
1st quartile	11,25
median	12,65
3rd quartile	13,9
max	16,55
mean	12,68889
stdev	1,75982

Course information

Teaching assistant is Odran Bonnet. Email: odran.bonnet@sciencespo.fr

Schedule: Tuesdays, 8am-10am, starting September 3, 2013.

Location: Albert Sorel – Leroy-Beaulieu (27, St Guillaume – 3^ème étage, escalier des amphis).

Validation: Midterm (3h) and Final exam (3h).

Description of the course

This course is intended to give the students an overview on how the main concepts from Economics are used to deal with financial risks. It will put together many of the financial concepts seen across the master in a coherent framework, and will demonstrate how they are used in practice to make decisions facing risk. Risk is considered from three point of views: households, firms and the state.

First, individual decisions of households facing risk (insurance, investment, saving) are explored using Markowitz and Sharpe’s portfolio theory, with its implications for the asset management industry (L2). The notion of market for risk is presented in Arrow and Debreu’s equilibrium framework, with an application to prediction markets (L3). The limits of the mainframe theory are presented based on recent developments from behavioral finance and from macroeconomics (L4).

Second, the point of view of the firm is taken. What drives exchanges of risk? Are firms risk averse? The question is examined in the light of the Modigliani and Miller paradigm, and its consequences for financial disintermediation (L5). Economic theory suggests individual incentives within firms are a key aspect of the risk-taking behavior of the latter; applications to CEO compensation and capital structure are explored (L6). The conditions for risk to be traded efficiently are not always met; the concept of “market failures” is investigated, in particular moral hazard and adverse selection, which threaten the existence of some markets (L7).

Third, the point of view of the state is discussed. What is the rationale for the state to interfere with individual risk decisions? First, paternalism: agents may not take optimal decision for themselves. We shall discuss the welfare state and alternative models (L8). Second, externalities: risk taking behavior by financial institutions may have negative consequences for other market participants. We shall explore the essence of systemic regulation and its main tools (L9). We shall discuss financial bubbles and crisis, and investigate the case  for policy intervention (L10).

Two lectures will conclude the course. A case study will draw lessons from the past crisis in terms of risk management (L11). The last lecture will open up perspectives, especially in terms of careers opportunities (L12).