Incomplete financial markets

Most theories that have been discussed in previous courses in finance have implicitly assumed complete markets and that all assets can be traded. A complete market would allow trading in important assets such as human capital or future projects. These features of the economy will lead to allocations and prices that are in-consistent with standard asset pricing models such as "Capital Asset Pricing Model (CAPM)". We will in this course show that options can make the market "almost" complete. It is therefore important that the assumptions on which we base our option pricing hold. One such critical assumption is the possibility of short-selling, i.e. selling assets that you do not own. The course also deals with the opposite, for example, when individuals cannot mortgage their future income; and how we should price an option contract to employee's (CEO) that cannot short the underlying asset. We will also give a background to Real Options, i.e. methods to evaluate investments where you have the flexibility to defer, expand and abandon the investment. The course will present some theories but is mostly focused on professional implementation of solutions to these problems.