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Information about Financial Economics

Financial economics is the branch of economics concerned with resource allocation over time. It is further distinguished from other branches of economics by its "concentration on monetary activities", in which "money of one type or another is likely to appear on both sides of a trade" [1].

The questions addressed by the discipline are typically framed in terms of "time, uncertainty, options and information" [2].
  • Time: money now is traded for money in the future.
  • Uncertainty (or risk): The amount of money to be transferred in the future is uncertain.
  • options: one party to the transaction can make a decision at a later time that will affect subsequent transfers of money.
  • Information: knowledge of the future can reduce, or possibly eliminate, the uncertainty associated with future monetary value (FMV).

Subject matter

Given its scope, as above, financial economics tends to deal with the workings of financial markets, such as the stock market, and the financing of companies, and includes the following subject areas: Budgeting, saving, investing, borrowing, lending, insuring, hedging, diversifying, and asset management. Because the future is never known with certainty, a central concern of financial economics is the impact of uncertainty on resource allocation.

Financial economics thus attempts to answer questions such as:
  • How are the prices of financial assets determined (stocks, bonds, currencies, and commodities)?
  • What are the effects of a company choosing different methods of financing its operations, such as issuing shares or borrowing?
  • What portfolio of assets should an investor hold in order to best meet his/her objectives?

Assumptions

Financial economics is based on several assumptions - chief amongst these, that financial decision makers are rational (see Homo economicus; Efficient market hypothesis). However, recently, researchers in Experimental economics and Experimental finance have challenged this assumption empirically. Further, these assumptions are challenged - theoretically - by Behavioral finance, a discipline primarily concerned with the rationality, or lack thereof, of economic agents.

Other common assumptions include market prices following a random walk, or asset returns being normally distributed. Empirical evidence suggests that these assumptions may not hold, and in practice, traders and analysts, and particularly risk managers, frequently modify the "standard models".

Important concepts

Finance journals

See also

External links and references

Theory General
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General areas of finance
Financial markets • Investment management • Financial institutions • Personal finance • Public finance • Mathematical finance • Financial economics • Experimental finance • Computational finance
Economics is the social science that studies the production, distribution, and consumption of goods and services. The term economics comes from the Greek for oikos (house) and nomos (custom or law), hence "rules of the house(hold).
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For the Parker Brothers board game, see risk (game)

Risk is a concept that denotes a potential negative impact to an asset or some characteristic of value that may arise from some present process or future event.
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Options are financial instruments that convey the right, but not the obligation, to engage in a future transaction on some underlying security. For example, buying a call option provides the right to buy a specified quantity of a security at a set strike price at some time on or
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Perfect information is a term used in economics and game theory to describe a state of complete knowledge about the actions of other players that is instantaneously updated as new information arises.
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In economics, a financial market is a mechanism that allows people to easily buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices
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A stock market is a market for the trading of company stock, and derivatives of same; both of these are securities listed on a stock exchange as well as those only traded privately.
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Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects.
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Business law
Business organizations
Basic forms:
Sole proprietorship
Corporation
Partnership
(General · Limited · LLP)
Cooperative
USA:
Business trust · LLC · LLLP
Delaware corporation
Nevada corporation
UK/Commonwealth:
Limited company
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asset is meant probable future economic benefits controlled by an entity as a result of past transactions or events and from which future economic benefits may be obtained.
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In financial markets, the stock capital of a corporation or a joint-stock company is the capital raised through the issuance, sale and distribution of shares. A person or organization that holds at least a partial share of stock is called a shareholder.
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bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity.
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Debt is that which is owed; usually referencing assets owed, but the term can cover other obligations. In the case of assets, debt is a means of using future purchasing power in the present before a summation has been earned.
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Investment or investing[1] is a term with several closely-related meanings in business management, finance and economics, related to saving or deferring consumption.
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An assumption is a proposition that is taken for granted, in other words, that is treated for the sake of a given discussion as if it were known to be true.
  • In logic, more specifically in the context of natural deduction systems, an assumption

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Homo economicus, or Economic man, is the concept in some economic theories of man (that is, a human) as a rational and self-interested actor who desires wealth, avoids unnecessary labor, and has the ability to make judgments towards those ends.
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In finance, the efficient market hypothesis (EMH) asserts that financial markets are "informationally efficient", or that prices on traded assets, e.g., stocks, bonds, or property, already reflect all known information and therefore are unbiased in the sense that they reflect the
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Experimental economics is a field of economics which uses experimental methods to evaluate theoretical predictions of economic behavior. In contrast to traditional economic empiricism, which relies on observing decisions in natural environments, experimental economics seeks to
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The goals of experimental finance are to establish different market settings and environments to observe experimentally and analyze agents' behavior and the resulting characteristics of trading flows, information diffusion and aggregation, price setting mechanism and returns
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A central concept in science and the scientific method is that all evidence must be empirical, or empirically based, that is, dependent on evidence or consequences that are observable by the senses. Empirical data is data that is produced by experiment or observation.
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The word theory has a number of distinct meanings in different fields of knowledge, depending on their methodologies and the context of discussion.

In common usage, people often use the word theory to signify a conjecture, an opinion, or a speculation.
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Behavioral finance and behavioral economics are closely related fields which apply scientific research on human and social cognitive and emotional biases to better understand economic decisions and how they affect market prices, returns and the allocation of resources.
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random walk, sometimes called a "drunkard's walk," is a formalization in mathematics, computer science, and physics of the intuitive idea of taking successive steps, each in a random direction.
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normal distribution, also called the Gaussian distribution, is an important family of continuous probability distributions, applicable in many fields. Each member of the family may be defined by two parameters, location and scale: the mean ("average",
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Financial risk management is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk, particularly Credit risk and market risk.
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The risk-free interest rate is the interest rate that it is assumed can be obtained by investing in financial instruments with no default risk. However, the financial instrument can carry other types of risk, e.g.
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The time value of money is based on the premise that an investor prefers to receive a payment of a fixed amount of money today, rather than an equal amount in the future, all else being equal.
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The Fisher separation theorem in economics asserts that the objective of a will be the maximization of its present value, regardless of the preferences of its owners. The theorem therefore separates management's "productive opportunities" from the entrepreneur's "market
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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
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In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices.
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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".
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