According to Adam Smith, participants in the earliest commercial systems traded goods for goods or goods for services. A shepherd, for example, might trade one sheep for a portion of a farmer’s produce or may offer to help harvest the farmer’s produce in return for a share. This system of exchange is known as barter.
The problem with barter is that it’s inefficient, requiring that each party have something the other wants and that a fair trade can be negotiated (what if the shepherd only wanted one-fifth of a sheep’s worth of produce?). The solution to this problem, of course, was money. Because money has a mutually agreed upon value and can be divided into useful increments, it is adaptable to any transaction. Further, its universal desirability makes it a much more practical currency than a sheep or a rutabaga.
As markets and finance grew more complicated, so too did the types of trades in which people engaged. The advent of different national currencies, for example, gave rise to an industry in foreign exchange, with speculators soon learning that there is money to be made in both currency conversion and currency speculation. These types of transactions—in which money is exchanged for money, rather than goods and services—are the subject of financial economics. In the modern world, financial economics focuses on matters of corporate finance, asset pricing, and stock and foreign exchanges markets.
Financial economics is the study of economics with a focus on transactions that are entirely monetary. This distinguishes the field from traditional economics, which, according to Stanford professor emeritus of finance William F. Sharpe, focuses on transactions in which money is exchanged for goods or services.
Sharpe explains that financial economics is distinguished not only by this focus but also by the field’s attention to four additional factors:
Financial economists seek to determine the fair value of assets by evaluating all relevant data points. They also try to anticipate what events might introduce uncertainty that would impact the risk associated with a particular transaction.
Like financial engineering and quantitative finance, financial economics is a highly quantitative field involving the aggregation of massive amounts of data, the application of complex mathematics, and the utilization of powerful computers to model markets and predict the likelihood of certain outcomes. It is typically applied to stock markets and foreign exchange markets, where quantifiable factors such as price fluctuation, inflation, interest rates, and gross domestic product impact the ultimate outcome of transactions.
Financial economics rests on two fundamental concepts. The first is portfolio theory, through which degrees of risk and probable return can be computed for different investments. These calculations allow for the creation of different investment portfolios that optimize return for investors with different risk tolerances.
The second concept is the capital asset pricing mode l, which can be used to calculate the appropriate rate of return for an asset based on the risk associated with that asset. The capital asset pricing model offers one method for determining whether a particular investment is worth the risk involved.
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A master’s degree in financial economics is typically a Master of Science (MSFE or MScFE), although some programs designate the degree a Master of Arts (MAFE). The program is often offered jointly by a university’s school of business and its department of economics. Like the master’s in financial engineering or the master’s in quantitative finance, the master’s in financial economics requires a high level of aptitude in advanced mathematics and computer science.
Financial economics combines economic theory and financial theory with quantitative analysis. It straddles the two worlds of traditional business training and more a theory-based quantitative approach. MSFE curricula often overlap with curricula for other quant disciplines like financial engineering and quantitative finance, but also overlap substantially with MBA curricula, particularly in the area of economics. Required courses typically cover:
Some core curricula include computer programming courses, others offer them only as electives.
MSFE students typically hold undergraduate degrees in economics, although engineering, natural science, computer science, and business majors are also well represented. Regardless of major, a strong background in mathematics and computing is prerequisite to entering this STEM-eligible program. Most programs require applicants to have previously completed courses in intermediate microeconomics, intermediate macroeconomics, economic statistics, linear algebra, intermediate calculus, and computer programming. Financial economics master’s programs are typically small and often include a substantial number of international students, particularly from southeast Asia, India, and China.
Experts in financial economics work in the following roles:
The MSFE prepares students for careers in commercial banking, investment banking, asset management, public policy, health care, real estate, technology, and any other sector where finance and economics converge.
ZipRecruiter reports that financial economics careers yield an average annual salary of about $115,500. Top-paying cities include several in the Bay Area (San Francisco, San Jose, Oakland); Lebanon, NH; and Seattle, WA. The site indicates that health care is the top-paying industry in this field.