Financial economics is a field of economics that deals with the deployment and allocation of resources, in an uncertain environment, across time as well as spatially and blends the study of finance with the methodology of economics. This branch of economics if further characterized by the heavy presence of monetary activities in which it is said that the money (of any type) is bound to appear on both sides of the trade.
Financial economists are primarily interested in predicting the individual choices of investors and hence they study the interrelations between the financial variables that include shares, interest rates and prices (which are contrary to the real economy). In contrast to finance which studies the markets trading financial products, financial economics focuses on the real or traditional variables of finance using an approach that is consistent with economics.
It studies and covers the topics such as,
- Valuation – which determines an asset’s fair value as well as assesses the assets risk quotient, its ability to produce cash flow, compares its price to similar assets and analyzes if the derived cash flow is dependent on other events or asset(s).
- Financial Instruments or Markets – that include commodities, stocks, bonds, derivatives and the money market instruments.
- Financial Regulations and Financial Institutions
- Financial Econometrics
Financial economists, instead of observing overall patterns, consider rates and prices as a product of the individual’s accumulated choices (who decide whether to buy or sell or not). The behavior of financial markets are predicted by the economists by estimating how the decision-making processes of the investors participating in the market are affected by the various factors. The field is primarily concerned with creating models that, from acceptable assumptions, derive policy or testable implications. Analysts can find the predicted conditions by plugging in market factors by using the equations that are described by financial economics theories.