Intermediate Financial Theory. Book • 3rd Edition • Authors: Jean-Pierre Danthine and John B Donaldson. Browse book content. About the book. Search in. By Jean-Pierre Danthine and John B. Donaldson; Abstract: Targeting readers with backgrounds in economics, Intermediate Financial Theory, Third Edition. Buy Intermediate Financial Theory (Academic Press Advanced Finance) on by Jean-Pierre Danthine (Author), John B. Donaldson (Author).

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Moreover if the investor cares only about the first two moments he will invest equal amounts in the assets to minimize variance. The problem to be solved is: Let us reason with the help of an example. At date 1, he consumes dnthine unit in either state.

Solutions to Exercises

However, each agent would most likely have a higher utility ex ante post-trade. Now we will use these observations. The link with the real side of the economy is also intermmediate apparent in the CCAPM which does provide a better platform to think about many important finqncial in asset management.

There the similarities are great: Given the value of the optimal z, the FOC wrt y can be written as: For an equally weighted portfolio: The concept is very useful since if are able to extract A-D prices from traded assets they enable us to price every complex security.

Both agents are risk averse and we would expect them to try to standardize period 1 consumption. For full investment in the risky asset the first order condition has to satisfy the following: The opposite will happen to B. This expression can be interpreted as p1 a demand function. Write the problem of a risk neutral agent: In general, there is an infinity of PO allocations.


The price process is as in e. The put option has a price of 3q1. From the viewpoint of social welfare there seems to be no argument not to search for the realization of a Pareto Optimum. Documents Flashcards Grammar checker.

To price a complex security from A-D prices, make up the portfolio of AD securities providing the same state-by-state payoff as the security to be priced and check what is the cost of this portfolio.

You may want to re-read the concluding comments of Chapter 1 at this stage. All individuals with increasing utility functions prefer A to B. This is not surprising since prices are derived from utility maximization of the relevant cash flows.

Agent 2on the other hand, is fully insured, thanks to complete markets. The implied allocations are thus: Would the world be much better with significantly more complete markets? He will be hurt.

Also, logarithmic utility function is DARA. But the final allocation will be modified and closer equal?

EconPapers: Intermediate Financial Theory

The valuation of the endowment stream is dantgine space 2. Solving the program for agent 1 gives the following FOC: For agent 1, this is because he is risk neutral. This statement is valid even if no A-D security is traded. In a world of heterogeneous information, the liquidity-based trades are supplemented by exchanges between investors who disagree and in 59 some sense agree to disagree about the fundamental valuation of the object being exchanged: Massachusetts Intermedixte of Technology.


In a simple closed economy, the most natural assumption is that the proceeds from the issue are redistributed to the agents in the economy and similarly that the payments are financed from taxes levied on the same agents. As a consequence, the increase in price may well lead to a fully rational increase in demand.

Both securities are in zero net supply. We would expect s. Each agent owns one half of the firm, which can employ simultaneously two technologies: Because of the variance term diminishing utility, consumption should be equated across states for each agent.

The first order conditions become, with market clearing conditions imposed: Furthermore the security pays relatively more in this particular state. If investors hold homogeneous expectations concerning asset returns, mean returns on risky assets -per dollar invested- will be the same.

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Only two moments of a distribution are relevant for comparison: Beyond considerations of efficiency, however, considerations of social justice might suggest some non-optimal allocations are in fact socially preferable to some Pareto optimal ones. Thus risk-neutral probabilities of the cash flow stream coincide with the risk neutral probabilities of the price of the asset.

This is a consequence of the incomplete market situation. Once again; fijancial agents are better off after trade.