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The Economics of Financial Markets. First Edition - Finance and Financial Markets. Second Edition

May 26, 2006

These two books represent very different views about how to explain the workings of financial markets. In The Economics of Financial Markets , Roy Bailey takes the rigorous economist's approach and provides a detailed treatment of the underlying theoretical concepts. In Finance and Financial Markets , Keith Pilbeam adopts a pragmatic, participant-based approach that emphasises the way the markets work in practice rather than focusing on the underlying principles. The books cover the same subject, but they have very different perspectives.

The economics of financial markets can be a daunting subject. Bailey explains the functioning of these important markets at an "intermediate level", that is, his text is appropriate for undergraduates who have a good grounding in economic principles - this is not a book for the novice.

As one might expect from such a book, it provides complete coverage of the important concepts involved. It starts with an overview of asset pricing, market efficiency and market structure, and moves on to decision-making under uncertainty. We are then presented with the standard mean-variance model for portfolio selection, which naturally leads to asset-pricing models - namely, the capital asset-pricing model and, after a discussion of the role of arbitrage, arbitrage pricing theory. This is followed by a useful chapter on intertemporal choice and the equity-risk premium puzzle. Subsequent chapters shift focus to fixed-income security valuation and the term structure of interest rates before analysing derivatives markets. Reflecting their importance both in terms of theory and as a major part of financial markets, the chapters on futures, swaps and options take up a third of the book.

Every chapter includes suggested further reading and a set of key references but, as this is more a monograph than a textbook, there are no end-of-chapter exercises or teacher's materials. That said, on the book's website, there are downloadable copies of the numerous illustrations, but unfortunately for prospective adopters there does not appear to be a set of teacher's materials, such as PowerPoint slides and so forth, which is now a standard feature of most textbooks.

In contrast, Finance and Financial Markets is designed to provide an introduction to those unfamiliar with the workings of financial markets and is clearly structured as a textbook. It covers the same ground as The Economics of Financial Markets and deals with all the major elements of domestic and international financial markets. The book describes and explains the structures and the instruments in a no-nonsense style aimed at providing the reader with practical knowledge of how the markets work without providing a detailed discussion of their theoretical underpinnings. The focus is very much on giving the student a practical perspective on how financial markets, institutions and instruments work.

Hence this book does not accentuate theoretical aspects. For instance, unlike Bailey, Pilbeam has little reference to the research evidence. However, each chapter suggests further reading and includes both a multiple-choice quiz and short-answer questions. I liked the format for these end-of-chapter exercises given the growing popularity of multiple choice as a means of assessment and as a way for students to quickly consolidate their understanding of key ideas. PowerPoint slides and answers to all the end-of-chapter questions can be downloaded from the book's website.

Since these two texts take quite different approaches and cover much the same ground, the question arises as to which to recommend. Apart from the obvious issue that The Economics of Financial Markets is not an introductory text but one where the reader has to have an understanding of basic economic principles, the books aim to explain the workings of financial markets in very different ways.

I see Finance and Financial Markets as being particularly useful for students who are not specialising in economics and finance but who nevertheless need to have some understanding of financial markets. An added advantage is that the book is generally light on mathematics. In contrast, given its emphasis on theoretical understanding, The Economics of Financial Markets is for those students who are studying economics and wish to understand the economic theory of financial markets in some depth - as is also the case for those taking finance as their primary area of study.

Peter Moles is senior lecturer in finance, Edinburgh University Management School.

The Economics of Financial Markets. First Edition

Author - Roy E. Bailey
Publisher - Cambridge University Press
Pages - 528
Price - £65.00 and £29.99
ISBN - 0 521 848 X and 61280 2

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