MATH 573: Financial Mathematics I Fall 2020
Where, when, and contact information
Time & place: Tuesdays and Thursdays, 1:00 – 2:30 p.m.
in 268 Weiser Hall and via Zoom
(Recorded lectures will be available on Canvas)
Instructor: Dominykas Norgilas, email dnorgila@umich.edu
Office hours: Tuesdays 3:00 – 4:30 p.m. and Fridays 9:00 – 10:30 a.m.
in 2863 East Hall or via Zoom
GSI: Berkan Yilmaz, email byilmaz@umich.edu
Office hours: Mondays, Wednesdays and Fridays, 11:30 a.m. – 12:30 p.m.,
via Zoom
Official course description This is an introductory course in Financial Mathematics. This course starts
with the basic version of Mathematical Theory of Asset Pricing and Hedging (Fundamental Theorem of Asset
Pricing in discrete time and discrete space). This theory is applied to problems of Pricing and Hedging of
simple Financial Derivatives. (Time permitting, the continuous time version of the proposed methods is
presented, culminating with the Black–Scholes model.) A part of the course is devoted to the problems
of Optimal Investment in discrete time (including Markowitz Theory and CAPM) and Risk Management
(VaR and its extensions). This course shows how one can formulate and solve relevant problems of financial
industry via mathematical (in particular, probabilistic) methods. Although Math 526 is not a prerequisite
for Math 573, it is strongly recommended that either these courses are taken in parallel, or Math 526 precedes
Math 573.
Prerequisites A good knowledge of probability theory, real analysis, and linear algebra is essential for this
course. Familiarity with basic notions of measure theory and discrete-time stochastic processes is helpful.
Required textbook For a large part of the course, I will follow the textbooks
• Stochastic Finance: An Introduction in Discrete Time by Hans Föllmer and Alexander Schied, fourth
edition, published by de Gruyter in 2016 (ISBN: 978-3110463446).
• Economics and Mathematics of Financial Markets Jaksa Cvitanic and Fernando Zapatero, published
by MIT PRESS in 2004 (ISBN: 978-0262532655).
Supplementary textbooks I recommend the following three textbooks for background information on
financial markets and probability theory:
• Options, Futures, and Other Derivatives by John C. Hull, 10th edition, published by Pearson in 2017
(ISBN 978-0134472089).
This is a great non-technical introduction to derivative securities and the mechanics of real-world
financial markets.
• Probability with Martingales by David Williams, published by Cambridge University Press in 1991
(ISBN: 978-0511813658).
This is an excellent, lean, and rigorous introduction to essential topics of (measure-theoretic) probability
theory.
• Stochastic Calculus for Finance I: The Binomial Asset Pricing Model by Steven E. Shreve, published
by Springer in 2004 (ISBN: 978-0387249681).
Course website Canvas. I will post announcements, homework assignments, and other resources there.
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Attendance You are strongly encouraged to attend class and take notes.
For students that are not in the Quant Program, attendance will be taken for the first two lessons according
to the LSA Class Attendance Policy. The department may give away your place in this course if you do not
attend both of the first two lessons.
Grading
Ingredient Date Percentage of final grade
Homework 30%
Midterm exam Tuesday, October 20, 2020 30%
End of class exam Friday, December 11, 2020 40%
Homework:
• There will be approximately six graded homework assignments.
• The submission deadlines will be announced when the assignment is posted. You will have approxi-
mately one and a half weeks for each assignment.
• You are encouraged to collaborate with other students on homework problems, but each student must
write up his or her assignment independently.
• Late submissions of homework will not be accepted and are awarded a zero grade. I will not give
make-ups for homework for any reason.
Exams: If you miss the midterm exam, then I will award you a zero grade, except in the case of documented
family or medical emergency. In that case, the homework and final exam grade will each account for 50% of
your final grade.
Guaranteed minimum grade:
[98, 100]: A+ [93, 98): A [90, 93): A-
[87, 90): B+ [83, 87): B [80, 83): B-
[77, 80): C+ [73, 77): C [70, 73): C-
[60, 70): D
[0, 60): E
Pass is equivalent to C-.
Testing accommodations If you think you need an accommodation for a disability, please let me know
as soon as possible. In particular, a Verified Individualized Services and Accommodations (VISA) form must
be provided to me at least two weeks prior to the need for a test/quiz accommodation. The Services for
Students with Disabilities (SSD) Office (G664 Haven Hall; http://ssd.umich.edu/) issues VISA forms.
LSA community standards of academic integrity The LSA undergraduate academic community,
like all communities, functions best when its members treat one another with honesty, fairness, respect, and
trust. The College holds all members of its community to high standards of scholarship and integrity. To
accomplish its mission of providing an optimal educational environment and developing leaders of society,
the College promotes the assumption of personal responsibility and integrity and prohibits all forms of
academic dishonesty and misconduct. Academic dishonesty may be understood as any action or attempted
action that may result in creating an unfair academic advantage for oneself or an unfair academic advantage
or disadvantage for any other member or members of the academic community. Conduct, without regard
to motive, that violates the academic integrity and ethical standards of the College community cannot be
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tolerated. The College seeks vigorously to achieve compliance with its community standards of academic
integrity. Violations of the standards will not be tolerated and will result in serious consequences and
disciplinary action.
Tentative course schedule
• Arbitrage theory in single-period models: assets, portfolios, arbitrage opportunities, derivative securi-
ties (with examples from equity, fixed-income and credit markets).
• Arbitrage theory in single-period models: hedging in complete markets and the Fundamental Theorem
of Asset Pricing in a one period model, geometric characterization of arbitrage-free models.
• Optimality and equilibrium in single-period models: Markowitz portfolio theory and CAPM.
• Optimality and equilibrium in single-period models: Von Neumann - Morgenstern expected utility,
exponential utility and relative entropy, Microeconomic equilibrium.
• Monetary measures of risk: risk measures and their acceptance sets, popular risk measures in a financial
market (including Value at Risk and Expected Shortfall), concave distortions.
• Review of necessary mathematical background: measures, filtrations, function spaces, etc.
• Arbitrage theory in multi-period models: binomial model, arbitrage opportunities and martingale
measures, European contingent claims.
• Arbitrage theory in multi-period models: hedging in complete markets and the Fundamental Theorem
of Asset Pricing in a multi-period model, exotic derivatives in binomial model (including Asian and
barrier options).
• Arbitrage theory in multi-period models: fixed income derivatives in a binomial tree model.
• Pricing and hedging American options in a binomial model: Dynamic Programming Principle and
Snell envelopes.
• Portfolio optimization in a multi-period model: dynamic hedging in incomplete markets (including
super- and sub-hedging, quadratic hedging, quantile hedging, and minimizing risk measures).
• Towards the Black-Scholes model: convergence of discrete-time models, pricing and hedging in a Black-
Scholes model, optimal investment in a Black-Scholes model, two-fund theorem.
