Craig W. Holden


BU 356C

Office Hours:

Tues-Thurs 2:15-4:00 or feel free to drop by any time!

Office Phone:



Holden web site:

Career Resources:




Welcome to the start of the finance sequence! This course will build the foundation for all of the finance courses to follow. Specifically, I have set four goals for each student to obtain:

   (1)  develop a fundamental knowledge of asset pricing theory under perfect capital markets,

   (2)  develop key analytic tools and modeling skills,

   (3)  develop basic academic writing skills and presentation skills, and

   (4)  gain exposure to research in asset pricing theory under imperfect capital markets.


Perfect capital markets is the base case to which nearly all models are compared. Hence, asset pricing theory under perfect capital markets is the foundation of nearly all finance research. Modeling skills are essential to success in all theoretical research and, to a lesser degree, in  empirical research. We will develop key analytic tools (continuous time techniques, solving PDEs, many portfolio problems, etc.) and discuss a variety of modeling tricks, traps, and techniques. Academic writing skills are critical to communicating your research ideas to other people. The written style of academic papers is unique, complex, and subtle. Hence, a major component of the original research paper will be developing skills at academic writing. A significant amount of current research in asset pricing theory is being done under imperfections of one kind or another. Hence, we will provide some exposure to this type of research.




My approach to teaching involves four key features:


1.      Assignment Preparation. There is an approximate schedule of assigned readings. You are expected to read all of the assigned readings before class. It is good to stay a little ahead of the schedule, in case we end up going a bit faster than the schedule.


2.      Class Participation. You are expected to be ready to lead the class discussion on any part of the assigned reading and to generally participate in the class discussion. Some of the time I will ask for volunteers to lead the class discussion and other times I will cold-call students to insure that everyone participates. This is an “active learning” approach, where students are the primary source of classroom learning and interaction.


3.      Clicker Participation. I will frequently ask clicker questions to the entire class. All students are asked to respond to these questions using their clickers. Two points will be given for a correct response and one point for an incorrect response. Total clicker points will be scaled to fit the grading scale listed below. Let me know if you change clicker devices so that I can track you and give you credit. No allowance will be made for forgotten clickers, battery failures, or missing class. You are not allowed to submit clicker responses for a classmate. We will use clicker channel 60.


4.      Learn By Doing. The best way to learn how to do research is to actually do research. The best way to learn how to present your research to others is to actually present your research to others. Therefore, you are expected to do an original research paper and to do a class presentation of your research.






Session Topics


Assignment Preparation

(1.) Jan 8

·         Ch. 1 An Introduction to No Arbitrage Pricing and Continuous Time.

·         The No Arbitrage Pricing Methodology.

·         The Binomial Approach To Continuous Time.


Reading: Holden Sect 1.1–1.2

Excel Models: Binomial Approach To Continuous Time

(2.) Jan 10

·         Diffusion Processes.

·         Four Special Cases.

Reading: Holden Sect 1.3–1.4, Shimko Pages 1-12


(3.) Jan 15

·         Ito’s Lemma.

·         Ch. 2 Asset Valuation.

·         Simple Examples.


Reading: Holden Sect 1.5–2.1, Shimko Pages 13-16, 19-21



(4.) Jan 17

·         Solutions To Frequently Occurring ODEs.

·         Jump Processes. 


Reading: Holden Sect 2.2–2.3, Shimko Pages 16-18, 21-23, 33-36

(5.) Jan 22

·         Separation of Variables.

·         Ch.3 Finite-lived Assets.

·         Simple Examples. 

·         Laplace Transform Technique.


Reading: Holden Sect 2.43.2, Shimko Pages 37-38, Appendix


(6.) Jan 24

·         Solutions To Frequently Occurring PDEs

·         Ch. 4 Options, Forwards, and Futures.

·         Introduction to Options and Forwards. 


Reading: Holden Sect 3.3–4.1, Shimko Pages 39-43, Hull Sect 1.1–1.10, 2.1–2.3, 9.1–9.4, 11.1–11.4

Excel Models: Trading Strategies Held To Maturity


(7.) Jan 29

·          Black-Scholes Formula.


Reading: Holden Sect 4.2, Hull 14.1–14.2, 14.6, 14.8–14.9

Excel Models: Black Scholes Option Pricing


(8.) Jan 31

·         Greeks and Trading Strategies



Reading: Holden Sect 4.3, Hull 18.1–18.9

Excel Models: Trading Strategies Over Any Horizon, Daily Delta Hedging




Session Topics


Assignment Preparation

 (9.) Feb 5

·         Kickoff Discussion of Original Research Paper

·         Binomial Option Pricing.




 Reading: Holden Sect 14.114.3, 4.4, Hull Sect 12.1–12.5

Excel Models: Binomial Option Pricing, Binomial Covergence to Normal, Binomial Covergence to Black Scholes


(10.) Feb 7

·         15-Minute Discussion of Student-Selected Articles



(11.) Feb 12

·         15-Minute Discussion of Student-Selected Articles



(12.) Feb 14

·         Risk-Neutral Valuation

·         Put-Call Parity.


Reading: Holden Sect 4.5–4.6, Hull Sect 10.4, 14.7, Appendix of Ch. 14


(13.) Feb 19

·         Applications of Put-Call Parity

·         Put-Call Parity with Foreign Currency.

·         Interest Rate Parity (IRP).

·         Futures vs. Forwards.


Reading: Holden Sect 4.7–4.10, Hull Sect 2.11, 5.7, 5.10, 5.12, Shimko Pages 70-72
Excel Models: Margin on Futures Contracts

(14.) Feb 21

·         Implied Standard Deviations (ISD’s).

·         Variations.

·         American Options

·         Exotic Options.

Reading: Holden Sect 4.114.14, Hull Sect , 10.5–10.6, 14.12, 16.1–16.2, 17.8, 25.6, 25.8, 25.10–25.12, 27.5–27.7

Excel Models: Implied Standard Deviations in Black Scholes Option Pricing, Exotic Options on Black Scholes Option Pricing

(15.) Feb 26

·         Pricing By Simulation.

·         Pricing By Finite Differences.

·         Ch. 5 Bond Pricing Basics.

·         Introduction To Default-free Bonds.


Reading: Holden Sect 4.155.1, Hull 20.6–20.8

Excel Models: Pricing By Simulation, Pricing By Finite Differences

(16.) Feb 28

·         Four Equivalent Ways of

Describing Bonds.

·         Duration, Immunization, and Convexity.


Reading: Holden Sect 5.25.3,

Excel Models: Bond Duration, Bond Convexity, US Yield Curve Dynamics

(17.) March 5

·         International Fisher Effect (IFE)

·         Swaps

·         Ch. 6 Term Structure Dynamics.

·         Single Factor Models.


Reading: Holden Sect 5.4–6.1, Hull Sect 7.7–7.9, 30.1-30.2
Excel Models: Affine Yield Curve

Session Topics


Assignment Preparation

(18.) March 7

·         Two Factor Models.

·         Arbitrage-free Models

Reading: Holden Sect 6.26.3, Hull Sect 30.3, 31.1


Spring Break



(19.) March 19

·         Ch. 7 Corporate Bonds

·         Structural Models

·         Reduced-Form Models

Reading: Holden Sect 7.1–7.2





(20.) March 21

·         Ch. 8 Individual Optimization.

·         Rational Vs. Irrational Agents.

·         Useful Utility Functions.

·         The Portfolio Problem.


Reading: Holden Sect 8.18.3, Ingersoll Pages 38-41


(21.) March 26

·         Mean-Variance Analysis.

·         The St. Petersburg Paradox


Reading: Holden Sect 8.4–8.5, Ingersoll Pages 82-89, 98

Excel Models: Portfolio Optimization




(22.) March 28

·         Ch. 9 Single Period Asset Pricing. 

·         Standard Supply and Demand Problem.


Reading: Holden Sect 9.1

(23.) April 2

·         CAPM.

·         APT.

·         Ch. 10 Multi-Period Asset Pricing in Discrete Time.

·         Dynamic Programming Three Cases.

·         Ch. 11 Multi-Period Asset Pricing in Continuous Time.

·         Constant Investment Opportunity Set and State Independent Utility.


Reading: Holden Sect 9.211.1, Ingersoll Pages 92-93, 98, 235-248 (ç just skim these pages), 271-276


 (24.) April 4

·         Live Exercise in Designing a Theoretical Study

·         Stochastic Investment Opportunity Set and/or State Dependent Utility.

·         Consumption CAPM.

·         Endogenous Riskfree Rate.

Reading: Holden Sect 11.211.4, Ingersoll Pages 280-282, 286-287


Session Topics


Assignment Preparation

(25.) April 9

·         15-Minute Research Paper Presentations



(26.) April 11

·         15-Minute Research Paper Presentations



(27.) April 16

·         CIR General Equilibrium Model.

·         Ch. 12 International Asset Pricing.

·         International Parity Conditions.


Reading: Holden Sect 11.412.1, Cox, Ingersoll, and Ross (1985a) (ç focus on big picture of this paper – I will explain the details)

Excel Models: International Parity

(28.) April 18

·         Solnik’s Model.

·         International Investment Problem


Reading: Holden Sect 12.212.3, Ingersoll Pages 289-290, Solnik (1974), Adler and Dumas (1983)

(29.) April 23

·         International Asset Pricing and Intertemporal State Variables.

·         Stylized Facts About International.


Reading: Holden Sect 12.412.5, Adler and Prasad (1992)




(30.) April 25

·         Ch. 13 Transaction Costs and Spatial Separation.

·         Transaction Costs.

·         Endogenous Real Exchange Rate.


Reading: Holden Sect 13.113.2, Dumas and Luciano (1989), Dumas (1992)


(31.) April 30

·         Round 3 Original Research Paper and Response to the Referee is due at 5:00 p.m.






1.       Grading is done on a curve based on total points for the course. The following items are graded:





Kick Off

Due Date

Class Participation in the First Half

Class Participation in the Second Half

100 points

100 points







Clicker Participation in the First Half

Clicker Participation in the Second Half

100 points

100 points







Original Research Paper:

  • Presentation Quality . . . . . . . .
  • Academic Writing Quality . . . . .
  • Substantive Quality . . . . . . . . . .


  80 points

  120 points

 200 points





Feb 5

April 30, 5:00 pm

Total Points

800 points





2.      I expect you to participate in the class discussion. I record class participation for each student immediately after class.




You are asked to lead a 15 minute class discussion while sitting in your chair (i.e., no PowerPoint) of a published or forthcoming article on Asset Pricing Theory. It can be pure theory article or a theory and empirical mix article, but there has to be true theoretical contribution in the article (i.e., there must be a proposition or a theorem in the article). The article must have been published in the years 2007 to the present or currently be forthcoming in the top-tier finance journals (JF, JFE, RFS, and JFQA) or in top-tier accounting or economics journals. To search for articles, try looking at the table of contents or recent issues, clicking on interesting abstracts, and then downloading the full articles that seem especially interesting.


15 minutes is a short amount of time. You need to focus on the big picture. You need to cover the overall motivation, key assumptions, and key results / intuitions. Don't get bogged down in the details and derivations. This is not a presentation, so PowerPoint is not permitted. Instead, you will lead the class discussion from your chair and I will show key article pages on the screen.


Article discussion sign-ups will begin on January 26 after class. Please supply a PDF file of the requested article in its final published form from the journal web site (not in its working paper form). Sign-ups will be first-come, first served. The PDF file of each selected article will be distributed to the entire class. Students are expected to give each selected article at least a 15 minute “quick read” prior to the class discussion. A quick read means completely reading the introduction and then selectively reading key parts, such as the assumptions, figures, propositions, data description, or tables.




   Options, Futures, and Other Derivatives, Eight Edition  by John Hull – The entire text is available by

   logging onto OnCourse, clicking on F600, and then clicking on Courseload. You have already paid

   for it! There is no need to purchase it a second time. If it doesn’t load, try a different browser.


   Notes for F600 Asset Pricing Theory  by Craig W. Holden

   Optional:  The Theory of Financial Decision Making by Jonathan Ingersoll 




I have created a zip file containing an electronic copy of the F600 notes, F600 books, F600 asset pricing articles, Excel models, handouts, and career resources. This zip file can be downloaded by logging into Oncourse ( and then clicking on the F600 tab, the Resources link, and the file F600 Electronic




You are to develop an original research paper following the three round process listed below.


Round 1.   Identify an asset pricing theory paper (on the syllabus, on the list of presentation articles, or elsewhere) and brainstorm three-to-five possible theoretical extensions that could be made to the model. The round 1 write-up (limit of one page write-up per extension – can be handwritten if you wish) should specify for each possible extension:

  • what the extension is
  • what is the motivation – why is this an interesting extension?
  • what key result you hope to obtain - what is new? what is surprising?  (Results sell  papers.)
  • the result’s theoretical significance,
  • the result’s empirical implication significance (if any),
  • the result’s practical significance (if any), and
  • the extension’s degree of difficulty.


Response 1.  Drop by my office and we will discuss the merits of each possible extension.


Round 2. Develop a “core model’ that captures the key economic idea that you want to address. Often you will need to iterate through a series of models/assumptions/approaches until you find one that is both tractable and which captures your key economic idea. Write up it up in the standard format of an academic paper. The body of the paper (excluding the title page, appendices, tables, or figures) is limited to 10 double-spaced pages with normal size font and one-inch margins all around. The literature review is limited to 1 page in the introduction. Journal space is very limited, so it is a good habit to learn to write your papers with a very tight, efficient use of space. Submit your paper as a PDF file to Your write up should include:

  • a title page, including the abstract
  • an introduction with motivation and intuition
  • a very brief literature review - focus on the one or two papers that are the most directly relevant

·         to your extension - I want you to focus your effort on your extension and not on reading extra articles.

·         the model set-up

·         step-by-step development of the model - explain each step once in math and a second time in words

·         flag key assumptions and results

·         optional: comparative statics and other ways to milk the model for all it is worth

·         a brief conclusion, including possible future extensions.


Class Presentation.  Develop a 15 minute, PowerPoint presentation for the class. Your presentation should explain:

·         what your are research question(s),

·         what is the motivation for this line of research,

·         what is your model setup, including key assumptions,

·         what are your key results to date, and

·         what are your key interpretations / intuitions for your results.

On the presentation date, please come to class a few minutes early and copy your presentation to the Windows Desktop of the classroom computer.


Response 2.   I will add comments on both the substance and exposition in your paper. I will send you an email that I have read your report and asking you to stop by my office. In my office I will provide additional explanation of my comments.


Round 3.   Incorporate a response to my comments. Add any additional results and polish the exposition. Write a one-page "response to the referee" report explaining with terse bullet points how you have responded to my comments and what additional items have been added. Submit your final version and your response to the referee report as PDF files to Your grade for the research paper substance and academic writing will be based on the Round 3 paper and response to the referee report. 


Important Dates:

Feb 21

The Round 1 write-up is due.

Feb 25, 26, or 27

Drop by my office to discuss the merit of each possible extension.

April 4 (early submissions welcome)

The Round 2 PDF paper submission is due.

April 8 or 10

15 minute presentation of your research to the class.

April 30, 5:00 p.m.

The Round 3 PDF paper and response to the referee report submissions are due.




·         Plagiarism is obvious. When a paper is 10 times more sophisticated that what a first or second year doctoral would produce, it is obvious. When a paper’s writing style is 10 times more polished compared that what a first or second year would produce, it is obvious. When a paper uses perfect English grammar compared to what a non-native English speaker would produce, it is obvious.

·         Plagiarism is easy to verify. Just take a unique sentence from the paper, type it into Google in quotes, and you will instantly get the plagiarized document. The entire published literature, all books, and all working papers are online. So everything worth plagiarizing is in Google’s index.

·         The penalties for plagiarism are severe. Anyone I catch will get an “F” in this class and, most likely, you would be dismissed from the doctoral program.

·         If you are in trouble, talk with me. The most likely context for plagiarism is that someone gets to a deadline and has nothing to turn in. I will understand your situation and will work with you. In the big picture, it is far better to get a lousy grade than to blow-up your career.




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Adler, M. and B. Prasad, 1992, "On Universal Currency Hedges," Journal of Financial and Quantitative Analysis, 27: 19-38.


Bakshi, G. and Z. Chen, 1997a, “An Alternative Valuation Model for Contingent Claims,” Journal of Financial Economics 44, 123-165.


Bakshi, G. and Z. Chen, 1997b, “Equilibrium Valuation of Foreign Exchange Claims,” Journal of Finance 52, 799-826.


Basak, S., 1996, “An Intertemporal Model of International Capital Market Segmentation”, Journal of Financial and Quantitative Analysis 31, 161-188.


Black, F., 1990, "Equilibrium Exchange Rate Hedging," Journal of Finance 45, 899-907.


Black, F., and J. Cox, 1976, “Valuing Corporate Securities: Some Effects of Bond Indenture Provisions,” Journal of Finance, 31, 351-367.


Black, F., and M. Scholes, 1973, "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, 81: 637‑54.


Brennan, M. and A. Kraus, 1978, "Necessary Conditions for Aggregation in Securities Markets," Journal of Financial and Quantitative Analysis, Sept.: 407-418.


Brennan, M. and E. Schwartz, 1979, "A Continuous Time Approach to the Pricing of Bonds," Journal of Banking and Finance, 3: 133-155.


Brennan, M. J., and E. S. Schwartz, 1980, “Analyzing Convertible Bonds,” Journal of Financial and Quantitative Analysis, 15, 907-929.


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Constantinides, G., 1986, "Capital Market Equilibrium with Transaction Costs," Journal of Political Economy, 94: 842-862.


Constantinides, G., 1990, "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, 98: 519-543.


Cox, J., J. Ingersoll Jr., and S. Ross, 1981a, "A Re‑examination of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, 36: 769‑99.


Cox, J., J. Ingersoll Jr., and S. Ross, 1981b, "The Relation between Forward Prices and Futures Prices," Journal of Financial Economics, 9: 321-346.


Cox, J., J. Ingersoll Jr., and S. Ross, 1985a, "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, 53: 385-408.


Cox, J., J. Ingersoll Jr., and S. Ross, 1985b, "A Theory of the Term Structure of Interest Rates," Econometrica, 53: 385‑407.


Cox, J., S. Ross, and M. Rubinstein, 1979, "Option Pricing: A Simplified Approach," Journal of Financial Economics, 7: 229-263.


Davis, M. and A. Norman, 1990, "On the Existence of a Stochastic Equilibrium," Mathematics of Operations Research, 15: 676-713.


Duffie, D. and C. Huang, 1985, "Implementing Arrow‑Debreu Equilibria by Continuous Trading of Few Long‑Lived Securities," Econometrica, 53: 1337‑56.


Duffie, D. and R. Kan, 1996, “A Yield-Factor Model of Interest Rates,” Mathematical Finance, 6: 379-406.


Duffie, D., and K. J. Singleton, 1999, “Modeling Term Structures of Defaultable Bonds,” Review of Financial Studies, 12, 687-720.


Dumas, B., 1989, "Two-Person Dynamic Equilibrium in the Capital Market," Review of Financial Studies, 2: 157-188.


Dumas, B., 1992, "Dynamic Equilibrium and the Real Exchange Rate in a Spatially Separated World," Review of Financial Studies, 5, 153-180.


Dumas, B. and E. Luciano, 1989, "An Exact Solution to a Dynamic Portfolio Choice Problem under Transaction Costs", Journal of Finance, 46: 577-595.


Errunza, V. and E. Losq, 1989, "Capital flow controls, international asset pricing, and investors' welfare: A Multi-Country Framework," Journal of Finance, 44: 1025-1038.


Epstein, L. and S. Zin, 1989, "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns I: A Theoretical Framework," Econometrica, 57: 937-69.


Geske, R., 1977, “The Valuation of Corporate Liabilities as Compound Options,” Journal of Financial and Quantitative Analysis, 12, 541-552.


Geske, R., and H. E. Johnson, 1984, “The Valuation of Corporate Liabilities as Compound Options: A Correction,” Journal of Financial and Quantitative Analysis, 19,



Geske, R., 1979, "The Valuation of Compound Options," Journal of Financial Economics, 7: 63-81.


Hakansson, N. H., 1970, "Optimal Investment and Consumption Strategies for a Class of Utility Functions," Econometrica, 38: 587‑607.


Harrison, J. M., and D. Kreps, 1979, "Martingales and Arbitrage in Multiperiod Securities Markets," Journal of Economic Theory, 20: 381‑408.


Harrison, J. M., and S. Pliska, 1981, "Martingales and Stochastic Integrals in the Theory of Continuous Trading," Stochastic Processes and Their Applications, 11: 215‑60.


Heath, D, R. Jarrow, and A. Morton, 1990a, “Bond Pricing and the Term Structure of Interest Rates: A Discrete Time Approximation,” Journal of Financial and Quantitative Analysis, 25: 419-440.


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F600 contributes to achieving the following doctoral program learning goals: (1) comprehensive and intensive disciplinary knowledge, (2) comprehensive and intensive knowledge of research methods, (3) communication of disciplinary research, and (4) evaluations of disciplinary research. The course teaches comprehensive and intensive disciplinary knowledge by teaching the key ideas in asset pricing theory, such as no arbitrage pricing, dynamic term structure models, individual portfolio optimization, single-period equilibrium, multi-period discrete equilibrium, continuous-time equilibrium, equilibrium with intertemporal state variables and state-dependent utility, international asset pricing, portfolio adjustment under transaction costs, real exchange rates under spacial separation, etc. The course teaches comprehensive and intensive knowledge of research methods by teaching the key research methods in asset pricing theory, such as continuous time stochastic processes, the binomial method, risk neutral pricing, solving partial differential equations, pricing by simulation, pricing by finite differences, dynamic programming, measurement currency, high-contact conditions, etc. and by having student do their own original research paper and providing individual feedback on the substance of their paper. The course teaches the communication of disciplinary research by having students present their own research to the class and by providing individual feedback on the academic writing quality of their paper. The course teaches evaluations of disciplinary research by discussing the strengths and weaknesses of each academic paper that we cover and by having each student lead a discussion of a recently published or forthcoming paper.



Doctoral Program Learning Goals


Goal 1: Comprehensive and Intensive Disciplinary Knowledge      

Students who earn a doctorate degree in business will be able to demonstrate a comprehensive and intensive knowledge of the theories, concepts, frameworks, empirical findings, and controversies in a chosen business discipline.


Goal 2: Comprehensive and Intensive Knowledge of Research Methods   

Students who earn a doctorate degree in business will be able to demonstrate a comprehensive and intensive knowledge of the research methods and analytical techniques applicable to a chosen business discipline.


Goal 3: Communication of Disciplinary Research   

Students who earn a doctorate degree in business will be able to design, conduct, and communicate – in both written and oral formats – original research that makes a substantial contribution to a selected business discipline.


Goal 4: Evaluations of Disciplinary Research         

Students who earn a doctorate degree in business will be able to evaluate research ideas and completed research projects critically, assessing their conceptual and methodological soundness and importance of contribution to existing knowledge in the field.


Goal 5: Teaching       

Students who earn a doctorate degree in business will be able to teach effectively in a selected discipline at the university level.