From: ACADEMIC EARTH on Fri, Apr 29 2011 3:45 PM

In the first part of the lecture we wrap up the previous discussion of implied default probabilities, showing how to calculate them quickly by using the same duality trick we used to compute forward interest rates, and showing how to interpret them as spreads in the forward rates. The main part ...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

This lecture continues the analysis of Social Security started at the end of the last class. We describe the creation of the system in 1938 by Franklin Roosevelt and Frances Perkins and its current financial troubles. For many Democrats, Social Security is the most successful government program ...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

Until now, the models we’ve used in this course have focused on the case where everyone can perfectly forecast future economic conditions. Clearly, to understand financial markets, we have to incorporate uncertainty into these models. The first half of this lecture continues reviewing the key st...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

In this lecture, we use the overlapping generations model from the previous class to see, mathematically, how demographic changes can influence interest rates and asset prices. We evaluate Tobin’s statement that a perpetually growing population could solve the Social Security problem, and resolv...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

In this lecture we move from present values to dynamic present values. If interest rates evolve along the forward curve, then the present value of the remaining cash flows of any instrument will evolve in a predictable trajectory. The fastest way to compute these is by backward induction. Dynami...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

Building on the general equilibrium setup solved in the last week, this lecture looks in depth at the relationships between productivity, patience, prices, allocations, and nominal and real interest rates. The solutions are given to three of Fisher’s famous examples: What happens to interest rat...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

In the 1990s, Yale discovered that it was faced with a deferred maintenance problem: the university hadn’t properly planned for important renovations in many buildings. A large, one-time expenditure would be needed. How should Yale have covered these expenses? This lecture begins by applying the...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

While economists didn’t have a good theory of interest until Irving Fisher came along, and didn't understand the role of collateral until even later, Shakespeare understood many of these things hundreds of years earlier. The first half of this lecture examines Shakespeare's economic in...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

Philosophers and theologians have railed against interest for thousands of years. But that is because they didn’t understand what causes interest. Irving Fisher built a model of financial equilibrium on top of general equilibrium (GE) by introducing time and assets into the GE model. He saw that ...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

Standard financial theory left us woefully unprepared for the financial crisis of 2007-09. Something is missing in the theory. In the majority of loans the borrower must agree on an interest rate and also on how much collateral he will put up to guarantee repayment. The standard theory presented ...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

Over time, economists' justifications for why free markets are a good thing have changed. In the first few classes, we saw how under some conditions, the competitive allocation maximizes the sum of agents' utilities. When it was found that this property didn’t hold generally, the idea ...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

This lecture explains what an economic model is, and why it allows for counterfactual reasoning and often yields paradoxical conclusions. Typically, equilibrium is defined as the solution to a system of simultaneous equations. The most important economic model is that of supply and demand in one...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

This lecture addresses some final points about the CAPM. How would one test the theory? Given the theory, what’s the right way to think about evaluating fund managers' performance? Should the manager of a hedge fund and the manager of a university endowment be judged by the same performance...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

Our understanding of the economy will be more tangible and vivid if we can in principle explain all the economic decisions of every agent in the economy. This lecture demonstrates, with two examples, how the theory lets us calculate equilibrium prices and allocations in a simple economy, either ...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

Until now we have ignored risk aversion. The Bernoulli brothers were the first to suggest a tractable way of representing risk aversion. They pointed out that an explanation of the St. Petersburg paradox might be that people care about expected utility instead of expected income, where utility i...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

This lecture gives a brief history of the young field of financial theory, which began in business schools quite separate from economics, and of my growing interest in the field and in Wall Street. A cornerstone of standard financial theory is the efficient markets hypothesis, but that has been ...

From: ACADEMIC EARTH on Fri, Apr 29 2011 3:44 PM

This lecture reviews the intuition from the previous class, where the idea of dynamic hedging was introduced. We learn why the crucial idea of dynamic hedging is marking to market: even when there are millions of possible scenarios that could come to pass over time, by hedging a little bit each ...

From: ACADEMIC EARTH on Mon, Feb 14 2011 7:43 PM

The virtuous circle of housing price appreciation making defaults go down making lending lax making housing appreciate even more.

From: ACADEMIC EARTH on Mon, Feb 14 2011 7:42 PM

How lower lending standards led to housing price inflation.

From: ACADEMIC EARTH on Mon, Feb 14 2011 7:42 PM

Why did housing prices go up so much from 2000-2006 even though classical supply/demand would not have called for it.