In basic microeconomics courses, it is explained how consumers choose between goods to maximize their utility at a certain point of time. In reality, consumers live over several periods, and face uncertainty about the future. Income fluctuates across time and across the different possible scenarios that the consumer can face. Given this fact, the consumer wants to smooth out her consumption across time (saving/borrowing) and across scenarios (insurance), hence the need for financial markets.

After an analysis of consumer decision making over time and in case of uncertainty, the course uses the Arrow-Debreu general equilibrium model to show how consumers may achieve an efficient market equilibrium when exchanging securities with one another. Yet, as next shown in the course, many deviations are observed empirically from the assumed rational consumer behaviour on which the general equilibrium model is based (micro puzzles). Also, some observed facts about financial markets, such as the equity premium puzzle, contradict the predictions of general equilibrium theory (macro puzzles). It is shown how these deviations and puzzles can be explained by a more psychologically-based theories of behaviour under uncertainty (prospect theory) and behaviour across time (hyperbolic discounting).

Learning objectives
The objective of this course is to provide students with the relevant microeconomic concepts and theories for the analysis and assessment of markets where market participants have to make inter-temporal decisions under uncertainty. The microeconomic insights are applied to financial markets.

At the end of the course the student is able to:

• understand the rational model of decision making under uncertainty and across time;
• build up general equilibrium theory from the rational model;
• apply general equilibrium theory to understand the determination of the prices of securities;
• understand psychologically-based models of decision making under uncertainty and across time;apply these psychologically-based
• models to explain puzzles at the level of individual behaviour and financial market outcomes

Format
Weekly lectures to impart the contents and introduce the models and weekly tutorials for solving exercises.

Assessment method

• Mid-term exam (30% of final grade);
• Final exam (70% of final grade, academic skill problem solving).

Effort requirements
Attendance at group meetings (at least 5 of the total of 7 tutorials)

Language of instruction
English/Dutch

Students are expected to have knowledge of
Intermediate Microeconomics (ECB2VMIE) or Advanced Mathematics (ECB2VWIS)