Quantitative Financial Economics

Course overview (Fall, 2022)

Lecturers
Name: Thomas Q. Pedersen (TQP) Name: Stig V. Møller (SVM)
Mail: tqpedersen@econ.au.dk Mail: svm@econ.au.dk
O¢ ce: Building 2631(K), Room 139 O¢ ce: Building 2631(K), Room 141b

Introductory remarks

In the following, you can …nd an overview of the di¤erent course topics as well as
information concerning the project work and the exam. The lectures take place each
Tuesday at 16:15 to 18:00 in E1 starting in week 36 and ending in week 41. At the lectures,
we will go through theory, methods and empirical illustrations. We will typically upload
lecture slides, Matlab programs used for empirical illustrations and problem sets well in
advance of the lectures. For each topic there may be multiple sets of slides structured
according to sub-topics. As supplementary material, we will also upload videos that
cover key takeaways. We do not expect that you go through the videos before attending
the lectures. The videos only serve as optional material that you may study at your
convenience.

During the course we will rely heavily on performing econometric analysis. We will
work with di¤erent time series such as stock prices, stock returns, price-dividend ratios,
interest rates, and so on. We therefore need to have a working knowledge of time-series
econometrics. We assume that most of you have access to the econometrics textbook
by Verbeek (2017) through participation in the course Econometrics 1. Otherwise, other
textbooks on time series econometrics will also su¢ ce. The key concepts that we will
draw on include stationarity, unit roots, cointegration, and vector autoregressive models.
In Verbeek (2017), these econometric topics are covered in chapters 8 and 9. Please note
that the most important sections are 8.1 to 8.5 and 9.2 to 9.4. For your convenience, we
will make videos available that cover the relevant material.

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Lectures
Topic Readings Lecturer Week
Introduction SVM 36
Cross-sectional asset pricing Fama and French (1996)

Cross-sectional asset pricing Petkova (2006) SVM 37

Time-varying risk premia Lettau and Ludvigson (2001)

Time-varying risk premia Goyal and Welch (2008) SVM 38

Present value relations Campbell and Shiller (1988) TQP 39

Cochrane (2008)

Rational bubbles Diba and Grossman (1988) TQP 40

Phillips et al. (2015)

Mutual fund performance evaluation Carhart (1997) TQP 41

Kosowski et al. (2006)

Matlab

We will use the program Matlab throughout the course to perform simulation exercises
and do empirical analyzes. For information about how to download and install the
program, follow this link: https://studerende.au.dk/en/it-support/software/matlab/. To
facilitate the best possible learning experience regarding Matlab, the code is commented
and often supplemented with a video. However, our experience is that you learn the most
by working actively with the program. So, use the Help function to learn more about
the program itself, functions etc. and play around with the code that we supply.

Project work

By the end of week 41 at the latest you should 1) have formed a group of up to
four students and 2) within the group decided on a topic for your project within the
course subject areas. During the second half of the semester, you work independently
but under supervision on your project and a …nal report not exceeding 48,000 characters
including spaces must be handed in by the end of the semester (about 20 normal pages).
Figures and tables count for 800 characters each. Note, 48,000 is the maximum number of

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characters and it applies irrespective of the number of students in the group. There is no
minimum number of characters. It is not the number of characters that decide your grade
in the course; it is how well you meet the learning objectives. More information about
the deadline for handing in the project will follow, but it will be sometime by the end of
the semester. In week 41 you will be asked to inform us about the group members and
the topic of your project, so that we can assign a supervisor to the individual projects.
More information on this as well as how we organize the supervision meetings will also
follow.

Project work allows you to work more in-depth with a given topic and it also prepares
you for your bachelor’s thesis in the spring. You will among other things get experience
with identifying an interesting research question, reviewing relevant literature, collecting
and working with data, programming and writing a well-structured report in a clear and
concise language. More details on what we expect your report to contain will follow at
the …nal lecture in week 41.

Exam

The exam consists in part of the report and in part of an oral exam. Your grade
will be based on an overall assessment of the two parts in accordance with the learning
objectives of the course. For the oral exam you will draw one of the …ve main topics of
the course:

1. Cross-sectional asset pricing.

2. Time-varying risk premia: predictive regressions, small sample bias and out-of-
sample regressions.

3. Present value relations: time-varying expected returns and joint hypothesis testing.

4. Rational bubbles.

5. Mutual fund performance evaluation.

However, you cannot draw the topic of your report e¤ectively leaving four topics for
the oral exam. At the oral exam, you are expected to independently give a presentation
of the topic, covering what you deem most important. The oral exam time is 20 minutes,
but this includes assessment, changing students and giving the grade. Consequently, you
can expect an e¤ective exam time of approximately 15 minutes with roughly 10 minutes

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devoted to your presentation and 5 minutes for questions. With only 10 minutes for
your presentation, you need to be selective in what you want to talk about at the exam.
Furthermore, be careful not to waste time on lengthy derivations. Time runs fast and
long derivations do not necessarily show that you have a …rm knowledge of the individual
topics. Instead, pick out key equations, models, …gures etc. and use these to guide your
presentation. Ultimately, you should be able to demonstrate a broad as well as in-depth
knowledge of the topics, so you should strive to …nd the right balance between the two.

Readings

The main literature in the course is:

Campbell, J.Y. and R.J. Shiller (1988). The dividend-price ratio and expectations of
future dividends and discount factors. Review of Financial Studies 1, 195-228.

Carhart, M.M. (1997). On persistence in mutual fund performance. Journal of Finance

52, 57-82.

Cochrane. J.H (2008). The dog that did not bark: A defense of return predictability.
Review of Financial Studies 21, 1533-1575.

Diba, B. and H. Grossman (1988). The theory of rational bubbles in stock prices. Eco-
nomic Journal 98, 746-745.

Fama, E.F. and K.R. French, K.R. (1996). Multifactor explanations of asset pricing
anomalies. Journal of Finance 51, 55-84.

Goyal, A. and I. Welch (2008). A comprehensive look at the empirical performance of

equity premium prediction. Review of Financial Studies 21, 1455-1508.

Kosowski, R., A. Timmermann, R. Wermers and H. White (2006). Can mutual fund
"stars" really pick stocks? New evidence from a bootstrap analysis. Journal of Finance
61, 2551-2595.

Lettau, M. and S. Ludvigson (2001). Consumption, aggregate wealth and expected stock
returns. Journal of Finance 56, 815-849.

Petkova, R. (2006). Do the Fama-French factors proxy for innovations in predictive

variables? Journal of Finance 61, 581-612.

Phillips, P.C.B., S. Shi and J. Yu (2015). Testing for multiple bubbles: Historical episodes
of exuberance and collapse in the S&P 500. International Economic Review 56, 1043-

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1077.

Verbeek, M. (2017). A Guide to Modern Econometrics. 5th edition, Wiley.

In addition to the main literature, some might …nd it useful also to consult a textbook.
Although they are not part of the curriculum and in some cases a bit outdated as well
as at a more advanced level, the following textbooks might prove helpful:

Campbell, J.Y, A.W. Lo and A.C. MacKinlay (1997). The Econometrics of Financial
Markets. Princeton University Press.

Cuthbertson, K. and D. Nitzsche (2004). Quantitative Financial Economics. Stocks,

Bonds and Foreign Exchange. 2nd edition, Wiley.