Quantitative Finance and Insurance

Fundamentals of calculus, statistics, econometrics, finance are prerequisites.
Essential background material is found in the following textbook:

Bodie Z., Kane A., Marcus A.J., Investments, McGraw Hill, – International Edition, senza scheda S&P. cap. 5-11, 13 e 24-27

This course focuses on asset pricing and quantitative investment management methods.

The first  part deals with asset pricing theory.

The second part addresses quantitative portfolio choice methods and their ex-post performance. Such methods account for investors' horizons, return predictability and estimation risk. 

The third part is devoted  to some special topics.

 

1. Knowledge and understanding ability

The first part of the course allows to recognize risk-based drivers of pricing in simple, static contexts. 

It will also show the drivers of return predictability.

Based on the second part of the course, students will be able to address the following issues:

1. Why should investors diversify across assets? Which are relevant characteristics of asset classes?

2. When should a worker reduce investment into stocks as retirement approaches? Which is the optimal asset allocation for a pension fund, that caters to a specific pool of workers?

3. Is it possible to reliably predict the return on one asset? On a portfolio of assets? On the relative return of two assets?... Are stock returns more predictable over a day, a month, a year, a decade? 

4. Do ex ante optimal portfolios perform better relative to simpler ones in ex post experiments? How large are gains from portfolio diversification across assets?

5. Are stocks safer in the long run? How large are gains from portfolio diversification over time? 

6. Why do “alternative assets” increase the Sharpe ratio of portfolios? Are the returns on such assets similar to those of other assets?

2) Capability to apply knowledge and understanding

The course enables to choose from a set of tools to cope with practical problems of risk assessment, portfolio management and asset pricing. For instance:

1. How to measure expected returns on different stocks on the basis of a small set of determinants. How to use existing assets to price redundant assets. How to identify arbitrage opportunities.

2. How to use asset pricing models to design long-short strategies? And portfolios with desired risk exposures. How to replicate a stock index? How to use asset pricing models to evaluate ex post performance of mutual funds?

3. How can a worker smooth consumption during working years (given labor income risk) and during retirement? Is she saving enough for retirement? Should a worker reduce investment into stocks as retirement approaches? Which is the optimal asset allocation for a pension fund?

4. Which techniques can a portfolio manager use to improve on ex- post performance?

5. How can we exploit predictability while optimizing the risk/return trade-off?

6. Can we use standard portfolio optimization tools to invest in alternatives? And what about ex-post performance measures: should we modify them to evaluate portfolios that include alternatives?

3) Capability to approach the subject in a critical manner

This is a key challenge.

The asset and risk management industry acts upon an evolving body of knowledge, so that the portfolio manager must be able to critically cope with new concepts and techniques. So as to train to this, we will present some unsettled issues - such as the possibility to exploit return predictability for improving portfolio performance -and the different actions to take depending on one's own critical assessment of the matter. 
We will also emphasize the difficulty in choosing to reduce risk taking when the asset manager's incentives are tilted towards maximizing short term returns.

4) Communication abilities

Students are expected to solve three problem sets in randomly-formed teams. 
If time allows, random participants in each team will be asked to present some results.

5) Learning ability

The reading list includes a variety of materials, from beginners' textbooks  to technical hadbooks and scientific papers. 
This ought to teach how to refer to different sources, when necessary. Lecture notes ease the approach to complex sources.

Class- work:

The entry test, during the first lecture, is based on Bodie Kane and Markus (see prerequisites).  Max Points 4.

There will be the possibility to retake the entry test once, in any of the official dates during the summer session. Pass grades at the entry test will be considered valid.

The entry test allows to understand whether most students know the basics. It consists of multiple choice questions and very simple exercises, drawn from Bodie Kane Marcus.   

EXAMS: the second part of the grade  (up to 26/30) is based on a test taken in the official usual exam dates.  

 

Weekly office hours during the course.

Review of the Basics   Mean Variance Optimization

                                             Equilibrium Pricing  and Arbitrage Pricing

                                             The 3-factor Model and Liquidity-adjusted Factor Model

                                              Some industry practices: performance evaluation, Treynor Black..

Risk-based Asset Pricing

1. Pricing with the Stochastic Discount Factor 

2. Efficient Frontier and CCAPM 
3. Return Predictability and Market Efficiency 
4.  Contingent Claim Pricing 
5. Risk Neutral Probabilities 
6. Equilibrium pricing in complete markets

Portfolio Choice 

7. Human Capital, Life Cycle Saving and Investing 
8. Return Predictability: Stylized Facts 
9. Estimation risk and ex post performance of optimal portfolios. 
10. Return Predictability and long term asset allocation 

Topics

11. Pricing votes and ownership structure

12. Pricing information (news, insider trading, Merton's investor base)

13. Investing in alternative assets  (higher order risk; hedge fund strategies, commercial real estate..)

14. Governance-based portfolio strategies

15. Tax arbitrage

16. Firm value and firm diversification

17. Risk measures

18. Liquidity and liquidity risk

19. "Smart" Investing and smart selling

20. The costs and benefits of securities regulation

Changes will be communicated at the beginning of the course.