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 and Portfolio Managment, McGraw Hill, –IX Edition, Global Edition, senza scheda S&P. cap. 1-11,13,21,24
or Bodie Kane Marcus, Investments, X Editon, 1-11,13,24,27

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. 

Professor Milo Bianchi, visiting from Toulouse School of Economics, will lecture for 16 hours  on Behavioral Finance.

 

 

1. Knowledge and understanding ability

Knowledge of market institutions , such as types of assets (stocks, treasuries, corporate bonds, options) and types  of  market intermediaries  (mutual funds, hedge funds, pension funds..)  is taken for granted.

A quick review  ensures that students are familiar with basic concepts and industry practices, such as  the role of portfolio diversification, the construction of mean-variance optimal portfolios, multifactor models, payoff replication, the Efficient Market Hypothesis , the distinction nbetween active and passive portfolio management and performance evaluation. 

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

It will also show the drivers of return predictability in a multiperiod set-up.

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/risk 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 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 divided in 6 teams during the third lecture, once registration is over. Three problem sets will be handed over. One team will present the solution to a problem set and another team will discuss it. Other teams may provide support when needed.

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.

The course is based on both  formal lectures and at least as many hours of at‐home
reading and solving exercises.

IMPORTANT NOTICE:  you are strongly advised to read in the Fall the intermediate-level  textbook by Bodie Kane Marcus. Selected chapters will be quickly reviewed during the first four weeks of the course, so as to homogenize the background of the classroom and prepare for advanced material.   

Students may be invited two attend finance research seminars and conferences at Collegio Carlo Alberto.

The exam tests both basic and advanced knowledge

Basics: 10 multiple choice questions drawn from Bodie Kane and Marcus in 10 minutes. If more than half of the answers are wrong, the advanced part will not be corrected.   

I will offer a test of the basics on May 12 at 12.30.  Those who pass it will not have to retake it in the Summer 2020.   

Advanced Material: there will be two composite questions or exercises, each on a different topic, with limited space for precise answers to the questions. See the sample exam on Moodle. 

Grades: test is worth up to 10; composite questions on advanced material will be worth 10 points each. 

ORAL EXAM FOR GRADES IN EXCESS of 26/30

All students with grades equal or greater than 27/30 from the Moodle part will go through a quick oral exam to validate their grade. Without the oral exam, the final grade will be 26/30. A student opt for a thorough oral exam with both upside/downside.

The exam at the time of Covidwill be ON MOODLE and WEBEX. You will receive a link the day before the exam, provided you signed up on ESSE3 as usual by the deadline. Please sign in Webex with your first and last name. Turn on your camera (facing you) and mic 15 minutes before the start of the Moodle test/exam and have your Smart Card ready. Log in Moodle 15 minutes before the exam. 

MATLAB OPTION: it is possible to SUBSTITUTE the Advanced Exam with a MATLAB program and interpret its output (max grade 16/30). Students wishing to pursue this option should notify Raffaele Corvino with an email with subject MATLAB OPTION by May 30.

Students will be asked to perform a proper quantitative analysis on real stock market data, applying the programming skills acquired during the course. Students will have to compose a Matlab script, running the commands that they learnt during the course and they think may be useful to complete the tasks. The Matlab script must be correctly working. Then, the students will have to interpret their results through the lens of the economic and financial background covered during the lectures. The final output of this option consists of two files: (1) the Matlab script, and (2) a Word document, where students will report their results and comments.

Timing: the tasks, together with the data, will be provided on the 19^th of June. The two output files must be submitted by the 9^th of July. The tasks must be completed individually.

4-Week Review              Optimal  portfolios and diversification

                                    CAPM

                                    The (Fama French Carhart) Multifactor model and payoff replication

                                    The EMH

                                    Empirical Asset Pricing   

                                    Performance evaluation                             

Basics  again                 1. Mean Variance Optimization with N risky asset

                                    2. Equilibrium Pricing  and Arbitrage Pricing

 Risk-based Asset Pricing: A Unifying Theory

                                    3. Pricing with the Stochastic Discount Factor 

                                    4. Generalized Efficient Frontier and CCAPM 
                                    5. Return Predictability, Market Efficiency and the EMH 
                                    6.  Contingent Claim Pricing 
                                    7. Risk Neutral Probabilities 
                                    8. Equilibrium pricing in complete markets

Portfolio Choice 

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

                                    13. Investing in Alternative Assets 

Topics for informal discussion

                                    Survivorship Bias

                                    Pricing votes and ownership structure

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

                                    Tax arbitrage

                                    Liquidity and liquidity risk

                                    The costs and benefits of securities regulation

Changes will be communicated at the beginning of the course.

The complete reading list wil be available on  Moodle at the beginning  of the course. It will comprise both book chapters and scientific papers.  

Review:  Bodie Kane and Marcus ch. 1-11, 13, 24

Students should be  familiar also with asset classes and investment companies (ch. 1-4, Bodie Kane Marcus)

Parts 3-8:  Cochrane J., Asset Pricing, Princeton University Press, 1999, Ch.1,2, 4.1,4.2,4.3, 5.1, 5.2,5.3 

Parts 9-12: Campbell J.Y and L. M. Viceira, Strategic Asset Allocation, Oxford Un. Press, 2002 , Ch. 6, Introduction; Ch. 6.1.1; Ch. 7 

**A new textbook covers Parts 1-11: Campbell J.Y. Financial Decisions and Markets, Princeton University Press, 2018**

We also study a few research papers during lectures.