bf chapter 1

5/24/2018 BF Chapter 1

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Cor orate Governance

Michael Christensen


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Michael Christensen

epar men o conom cs an us ness

School of Business and Social Sciences

Building 2632, Room 134

E-mail: mic asb.dk

Phone: +45 871 65001

,

PhD, University of Southampton, England

Practical experience:

7 years in a bank, broker company and Dansk Supermarked.


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Active learning

ec ures:

Teaching will be in Danish and

Blackboard (math. and examples) will be in EnglishPower Point slides (text) will be in English !

Exercises:

Part of each lecture

End of chapter questions:

Exam preparation successively:

u p e c o ce es s

Old exams


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Lucy F. Ackert and Richard Deaves

Chapter 1

Michael Christensen


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Neoclassical economics

e as c assump on o neoc ass ca econom cs s a consumers

and firms act rationally, i.e. consumers maximize utility, and firms

maximize profits.

The rationality assumption is a convenient way to analyze

economic behaviour and often economic modellin becomes

easier if we assume that economic agents behave rationally whenmaking economic decisions.

In the ideal neoclassical world there is no uncertainty; this makes

decision-making uncomplicated. However, the real world is, -

expectations into account.


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en econom c agen s ma e ec s ons ase on expec e va ues

(state of nature), the neoclassical theory assumes that they make

use of all public information, which implies that financial marketsbecome informationally efficient.

The im lication of an informationall efficient ca ital market is that

asset prices will be unpredictable, i.e. no investor will be able toearn an abnormal return. The return on any asset will reflect the

.

Most investors are risk-averse, which means that they dislike risk.,

and prefers less risk to higher risk.


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e can sum up:

1. Consumers have rational preferences across possibleoutcomes or states of nature.

2. Consumers maximize utility, and firms maximize profits.

3. Consumers make inde endent decisions based on all relevant

information.

Expected utility

used to make optimal choices among scarce resources in an

economy, where the future is uncertain.


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Expected utility

e s ngu s e ween or na an car na u y. u y can e

measured cardinally, we can relate specific numbers to the utility of

products or services, e.g. that the utility of apples is 15, oranges 10and bananas 5. These numbers can be interpreted as the

satisfaction received.

If utility is ordinal, we can only measure whether one product ispreferred to another product, e.g. that apples are preferred to

grapes.

1. Preferences are complete

. re erences are rans ve

#1


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Expected utility

e expec e u y eory says a n v ua s s ou ac w en

confronted with decision-making under uncertainty in a certain way.

The theory is really set up to deal with risk, not uncertainty:

Risk is when ou know what the outcomes could be and ou

can assign probabilities.

come up with a list of possible outcomes.

,

implies that the marginal utility is positive and diminishing.


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Expected utility

Examples of concave utility functions:

U(W) = ln(W)

10

12

U(W) = W

4

6

8

ln(W)

SQRT

Reciprocal

U(W) =W

0

2

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

CRRA

U(W) =1 a

W 1

1 a

2

#2


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Exercise 1

ow a e ons an e a ve s vers on u y

function:

1 a

U(W) =1 a

where W = wealth and a = the risk aversion parameter hasconstant Relative Risk Aversion.

#3


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Supplementary readings

r s ensen, ., : e nves er ng, s or ag. ap er ,

(Danish).

Copeland, T.E, J Fred Weston and K. Shastri, (2005), Financial

Theory and Corporate Policy, Pearson. Chapter 3.

bf chapter 1

Documents

exams5242018 bf chapter

utility of apples

expected utilitye s

marginal utility

neoclassical theory

higher risk

n v ua s s ou ac w

ideal neoclassical world