Finance theories Finance theories Arbitrage pricing theory (APT) holds that the expected return of a financial asset can be modelled as a linear function of various macro-economic factors, where sensitivity to changes in each factor is represented by a factor specific beta coefficient. The model derived rate of return will then be used to price the asset correctly - the asset price should equal the expected end of period price discounted at the rate implied by model. If the price diverges, arbitrage should bring it back into line. The theory was initiated by the economist Stephen Ross in 1976. ...more on Wikipedia about "Arbitrage pricing theory"
The Arrow-Debreu model is the central model in the General (Economic) Equilibrium Theory and often used as a general reference for other microeconomic models. It is named after Kenneth Arrow and Gerard Debreu. ...more on Wikipedia about "Arrow-Debreu model"
In finance, the binomial options pricing model provides a generalisable numerical method for the valuation of options. The binomial model was first proposed by Cox, Ross and Rubinstein (1979). Essentially, the model uses a "discrete-time" model of the varying price over time of the underlying financial instrument. Option valuation is then via application of the risk neutrality assumption over the life of the option, as the price of the underlying instrument evolves. ...more on Wikipedia about "Binomial options pricing model"
The Black model (sometimes known as the Black-76 model) is a variant the Black-Scholes option pricing model. It is widely used in the futures market and interest rate market for pricing bond options. It was first presented in a paper written by Fischer Black in 1976. ...more on Wikipedia about "Black model"
The Black-Scholes model, often simply called Black-Scholes, is a model of the varying price over time of financial instruments, and in particular stocks. The Black-Scholes formula is a mathematical formula for the theoretical value of European put and call stock options that may be derived from the assumptions of the model. The equation was derived by Fischer Black and Myron Scholes; the paper that contains the result was published in 1973. They built on earlier research by Paul Samuelson and Robert Carhart Merton. The fundamental insight of Black and Scholes is that the call option is implicitly priced if the stock is traded. The use of the Black-Scholes model and formula is pervasive in financial markets. ...more on Wikipedia about "Black-Scholes"
The capital asset pricing model (CAPM) is used in finance to determine a theoretically appropriate price of an asset such as a security. The formula takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), in a number often referred to as beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset. ...more on Wikipedia about "Capital asset pricing model"
In marketing, the decoy effect (also called the asymmetric dominance effect) is used to describe the phenomenon of greater consumer preference for an item in a two-item choice set caused by the addition to the choice set of a third item that is asymmetrically dominated. An asymmetrically dominated item is in one way better than one of the items, but in no way better than the other item. ...more on Wikipedia about "Decoy effect"
The equity premium puzzle refers to the phenomenon that observed average annual returns on stocks over the past century are higher, by approximately 6 percentage points, than returns on government bonds. Economists expect arbitrage opportunities would reduce the difference in returns on these two investment opportunities to reflect the risk premium investors demand when investing in relatively more risky stocks. The puzzle arises as the observed difference in returns implies an implausibly high level of risk aversion. That is, economists predict the difference in returns between these two investments should be much smaller than 6 percentage points. To quantify the level of risk aversion implied, investors would have to be indifferent between a bet with a 50 per cent chance of $50,000 or $100,000 and a certain payoff of $51,209. ...more on Wikipedia about "Equity premium puzzle"
The Gordon model, also called Gordon's model or the Gordon growth model is a variant of the discounted dividend model, a method for valuing a stock. It is named after Myron Gordon, who is currently a professor at the University of Toronto. ...more on Wikipedia about "Gordon model"
In financial mathematics, the Ho-Lee model is a Short rate model of future interest rates. It is the simplest model that can be calibrated to market data, by implying the form of from market prices. ...more on Wikipedia about "Ho-Lee model"
In financial mathematics, the Hull-White model is a model of future interest rates. It is relatively straight-forward to translate the mathematical description of the evolution of future interest rates on to a tree or lattice and so interest rate derivatives such as bermudan swaptions can be valued in the model. ...more on Wikipedia about "Hull-White model"
In economics, the Legal Origins Theory states that many aspects of a country's economic state of development are the result of their legal system, most of all where a particular country received its law from. The first papers on the theory were published from 1997 onwards by a group of researchers around Andrei Shleifer. ...more on Wikipedia about "Legal origins theory"
Description: The book is usually considered to be the beginning of modern economics. It begins with a discussion of the Industrial Revolution. Later it critiques the mercantilism and a synthesis of the emerging economic thinking of his time. It is mostly known due to the idea of The Invisible Hand which is an often quoted phrase from the book. Its meaning is that people will unintentionally improve their community through pursuit of their own wants and needs. The Butcher, the Baker, and the Brewer provide goods and services to each other out of self-interest; the unplanned result of this division of labor is a better standard of living for all three. ...more on Wikipedia about "List of publications in economics"
Modern portfolio theory (MPT) proposes how rational investors will use diversification to optimize their portfolios, and how an asset should be priced given its risk relative to the market as a whole. The basic concepts of the theory are the efficient frontier, Capital Asset Pricing Model and beta coefficient, the Capital Market Line and the Securities Market Line. ...more on Wikipedia about "Modern portfolio theory"
The Modigliani-Miller theorem (of Franco Modigliani, Merton Miller) forms the basis for modern thinking on capital structure. The basic theorem states that, in the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed. It does not matter if the firm's capital is raised by issuing stock or selling debt. It does not matter what the firm's dividend policy is. The theorem is made up of two propositions which can also be extended to a situation with taxes. ...more on Wikipedia about "Modigliani-Miller theorem"
The prospect theory was developed by Daniel Kahneman and Amos Tversky in 1979. Starting from empirical evidence, it describes how individuals evaluate losses and gains. In the original formulation the term prospect referred to a lottery. ...more on Wikipedia about "Prospect theory"
In financial mathematics, put-call parity defines a relationship between the price of a European call option and a European put option - both with the identical strike price and expiry. No assumptions other than a lack of arbitrage in the market are made in order to derive this relationship. ...more on Wikipedia about "Put-call parity"
The random walk hypothesis is a financial theory, close to the efficient market hypothesis, stating that market prices evolve according to a random walk and thus cannot be predicted. ...more on Wikipedia about "Random walk hypothesis"
Rates of Return (ROR): can apply to a number of different equations, these are as follows: ...more on Wikipedia about "Rates of Return"
Rational pricing is the assumption in financial economics that asset prices (and hence asset pricing models) will reflect the arbitrage-free price of the asset as any deviation from this price will be "arbitraged away". This assumption is useful in pricing fixed income securities, particularly bonds, and is fundamental to the pricing of derivative instruments. ...more on Wikipedia about "Rational pricing"
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