Spring 2004

Economics 252B

Robert Shiller
30 Hillhouse Ave., Room 23a, 432-3708

Administrative Assistant: carol.copeland@yale.edu, 432-3726, 30 Hillhouse Ave., Room 11a


Financial institutions are a pillar of civilized society, supporting people in their productive ventures and managing the economic risks they take on. This course seeks to offer understanding of the multiple aspects of our financial methods, as they have come to us through past invention and as they are evolving towards a future where financial tools are even more integrated into our lives than they are today. The course considers the multitude of problems in a rapidly developing world economy from the viewpoint of an evolving financial framework, incorporating theoretical and technical advances as they appear through time.

This course considers existing financial markets, institutions and methods from a number of standpoints. A broad description of the institutions we have today around the world is offered by Fabozzi, Modigliani, Jones and Ferri, Foundations of Financial Markets and Institutions. A rich description of the workings of some of those markets is offered in Siegel’s Stocks for the Long Run. Some of the most important unifying themes of this course are offered in my own book The New Financial Order; Risk in the 21st Century.

One of the themes of this course is the power that abstract financial theory offers for financial innovation. The theory gives generality to methods that might otherwise be applied only narrowly and diffidently.

Another theme of this course is the role of invention in advancing finance. Financial tools have many working parts whose functioning is not obvious to all but the most initiated. Financial tools, like other inventions, are, once discovered, copied around the world.

Another theme of this course is the importance of understanding human psychology in designing and using financial tools. The developing field of behavioral finance offers many insights into the working of our financial institutions. People are not coldly rational in their financial decision making, and yet most people are able to make financial decisions that are basically productive. Dealing productively with human strengths and weaknesses has been a challenge for those who develop financial methods.

Another theme of this course is the gradual democratization of finance through time. The principles of risk management were once available only to a few, but as time goes on, to more and more people, and applying to more and more risks that everyone faces. This democratization has been a major reason for the advance of our civilization, and will be in the future.

Another theme of this course is the difficult battle against moral hazard, and the many-faceted methods that have been developed to deal with this problem. Any risk management method carries with it an array of incentives and disincentives, some of which are productive and others destructive. The design of financial tools must respond to experience with moral hazard and to our knowledge of human psychology to minimize moral hazard.

Another theme of this course is predicting the nature of change in our financial system in the future in light of technical advances in areas outside of finance. Advances in information technology have been behind many of our most important financial innovations in the past, and even more rapid advances in information technology in the future will enable some fundamental improvements in our risk management.

The course offers a synopsis of financial theory, including such things as the capital asset pricing model and the theory of derivatives pricing. The course is attentive to the major financial institutions and methods of our day: insurance, portfolio management, underwriting, corporate management of dividends and debt, real estate finance, monetary policy, investment banking, brokerage, consumer finance, forwards and futures, options, swaps, as well as government public financial institutions of taxation and social security.