What Is Financial Economics?

Financial economics is a branch of economics that analyzes the use and distribution of resources in markets. Financial decisions must often take into account future events, whether those be related to individual stocks, 澳洲幸运5官方开奖结果体彩网:portfolios, or the market as a whole.

How Financial Economics Works

Making financial decisions is not always a straightforward process. Time, risk, 澳洲幸运5官方开奖结果体彩网:opportunity costs, and information can create incentives and disincentives. Financial economics em𓆏ploys economic theory to evaluate how certain things impact decision-making, providi🔯ng investors with the instruments to make the right calls.

Financial economics usually involves the creation of sophisticated models to test the variables affecting a particular decision. Often, these models assume that individuals or institutions making decisions act rationally, though this is not necessarily the case. The irrational behavior of🌊 parties has to be taken into account in financial economics as a potential risk factor.

This branch of economics builds heavily on 澳洲幸运5官方开奖结果体彩网:microeconomics and basic accounting concepts. It is a quantitative discipline that uses 澳洲幸运5官方开奖结果体彩网:econometrics as well as other mathematical tools.

Financial economics studies fair value, risk and returns, and the financing of securities and assets. Numerous monetary factors are taken into account, including interest rates and inflation.

Financial Economics vs. Traditional Economics

Traditional economics focuses on exchanges in which money is one—but only one—of the items traded. In contrast, financial economics concentrates on exchanges in which money of one type or another is likely to appear on both sides of a tra✨de. 

🃏The financial economist can be distinguished from traditional economists by their focus on monetary activities in which time, uncertainty, options, a🙈nd information play roles. 

Financial Economics Methods

T🐻🎐here are many angles to the concept of financial economics. Two of the most prominent are:

Discounting

Decision-making over time recognizes the fact that the value of $1 in 10 years' time is less than the value of $1 now. Therefore, the $1 at 10 years must be discounted to allow for risk, 澳洲幸运5官方开奖结果体彩网:inflation, and the simple fact that it is in the future. Failure to discount appropriately can lead to problems, such as underfunded pension schemes.

Risk Management and Diversification

Advertisements for stock market-based financial products must remind potentia🍨l buyers that the valꦿue of investments may fall as well as rise.

Financial institutions are always looking for ways of insuring, or hedging, this risk. It is sometimes possible to hold two highly risky assets but for the overall risk to be low: if share A only performs badly when share B performs well (and vice ver🌳sa) then the two shares perform a perfect hedge.

An important part of finance is working out the total risk of a portfolio of risky assets, since the total risk may be less than the risk of the individu♏al components.

The Bottom Line

Financial economics is a branch of economics that analyzes the use and distribution of resources in markets. Financial economi😼sts evaluate how variables like time, risk, and information should weigh in decision-making. The field considers critical factors including fiscal and monetary policy when calculating potential returns on investments and evaluating whether to invest in certain securities and assets.