FINANCE
Senior Lecturer of Finance
Donald P. Jacobs Scholar
We consider a market signaling game in which the market observes both the sender's costly signal as well as a stochastic grade that is correlated with the sender's type. We characterize equilibria satisfying stability-based refinements using an algorithmic approach and provide conditions under which the equilibrium is unique. When the test is sufficiently informative, separating equilibria do not survive---the mere presence of an informative test necessitates pooling. Unlike gradeless models, the equilibrium depends on the prior---it involves full pooling when the prior puts sufficient weight on the high type and partial pooling otherwise. We derive conditions under which the equilibrium converges to the fully efficient outcome as the proportion of high types goes to one---resolving a long-standing paradox within the signaling literature.
We study a dynamic setting in which stochastic information about a privately-informed seller's type is gradually revealed to a market of buyers. We characterize the unique equilibrium in a continuous-time framework. The equilibrium involves periods of no trade or market failure. The no-trade period ends in one of two ways: either enough good news arrives restoring confidence and markets reopen or bad news arrives making buyers more pessimistic forcing market capitulation i.e., a sell-off of low value assets. Reservation values arise endogenously from the option to sell in the future. Our model also encompasses both lemons and signaling environments: in a dynamic setting with sufficiently informative news, the two environments have the same equilibrium.
This paper explores the role of news in financial markets with asymmetrically informed traders. A single indivisible asset can be exchanged between asymmetrically informed traders whose time preference for money changes over time due to the arrival of random liquidity shocks. Meanwhile, information about the asset type is revealed gradually to uninformed traders. In equilibrium, the price is determined not only by uninformed traders' beliefs about the fundamental value of the asset, but also by expectations of future liquidity in the market. Assets are traded when market beliefs are sufficiently positive or sufficiently negative with periods of no-trade in between. The model helps to explain a number of frequently observed trading patterns. Evidence from the mortgage-backed securities market is discussed.
This course counts toward the following majors: Analytical Finance, Finance
This course studies the effects of time and uncertainty on decision making. Topics include discounted cash flow valuation, stock and bond valuation, the term structure of interest rates, bond duration, capital budgeting under certainty and uncertainty, portfolio theory, asset pricing models and efficient markets.
Prerequisites: Knowledge of (a) probability and statistics through linear regression and (b) financial accounting. Requirement (a) may be satisfied with prior or concurrent registration in DECS-434, sufficient previous course work in statistics or attending Finance I statistics tutorials (available fall quarter only). Requirement (b) may be satisfied with prior or concurrent registration in ACCT 430 or sufficient previous course work in financial accounting. MECN-430 is recommended.
To qualify for a Finance I (FINC-430) waiver, you must have passed a comparable course with a grade of A. The type and level of material covered in the course are represented by chapters 1-13 and 23 of the text by Brealey and Myers, Principles of Corporate Finance. You need not request a Finance I waiver to enroll in FINC-440 (Turbo). To help you decide whether you should waive Finance I, take the self-assessment test online at www.kellogg.northwestern.edu/finance/curriculum/finance1waiver.htm.
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