CM2 Economic Modelling: Topics and Study Guide

How to prepare Economic Modelling

1. Read the syllabus and map your 16 chapters to its five topic areas. Note which chapters feed asset valuations, liability valuations and option theory, and give those the most study hours.
2. Start with the foundations: rational expectations and the efficient markets hypothesis, utility theory, risk measures and the role of insurance. Learn the definitions and the assumptions behind each one. These ideas are reused in later chapters.
3. Move to portfolio theory next: mean-variance theory, CAPM and single and multifactor models. Practise the calculations by hand, such as portfolio variance and expected return. Then be able to explain what each result means for an investor.
4. Study the stochastic models: security price models, term structure models and simple credit risk models. Write out each model's assumptions, its key equations and its limitations. Examiners often ask you to comment on whether a model is suitable.
5. Cover the liability-side chapters: ruin theory, run-off triangles and valuing benefit guarantees by simulation. Work through full numerical examples, and practise setting out the method step by step.
6. Spend extra time on option theory: principles of option pricing, the binomial model and Black-Scholes. Practise no-arbitrage arguments, put-call parity, and building and using binomial trees. Learn how the Black-Scholes assumptions affect the result.
7. Practise for Paper B throughout, not at the end. Use R or the tools your session requires to simulate, fit and calculate. Keep a short note of the commands and the steps you use, and practise writing brief interpretations of your output.
8. In the last weeks, do full past papers under timed conditions. Mark them honestly against the examiners' reports, list your repeated errors, and revise those topics. Keep a one-page list of key formulas and assumptions for each chapter.

Time management in the exam

• →Before you start, scan the whole paper. Note the question structure and the marks for each question, then plan your time in proportion to the marks.
• →Aim for roughly one minute per mark as a guide. On a 100-mark paper of 3 hours 15 minutes, this leaves a small buffer for reading and checking.
• →Answer the questions you are surest of first. This builds marks early and leaves more time for the hard derivations.
• →If you are stuck on a calculation, write down the method and formula, move on, and return later. Method marks are often available even when the final number is wrong.
• →In written parts, keep explanations short and tied to the model. A clear statement of the assumption or the meaning of a result earns marks faster than a long essay.
• →Keep the last 10 minutes for checking units, signs, notation and that every part of each question has an answer. For Paper B, save your work regularly and check that your output matches what the question asked.