A Behavioral Approach to Asset Pricing


  • Hersh Shefrin, Mario L. Belotti Professor of Finance, Leavey School of Business, Santa Clara University, CA, USA

Behavioral finance is the study of how psychology affects financial decision making and financial markets. It is increasingly becoming the common way of understanding investor behavior and stock market activity. Incorporating the latest research and theory, Shefrin offers both a strong theory and efficient empirical tools that address derivatives, fixed income securities, mean-variance efficient portfolios, and the market portfolio. The book provides a series of examples to illustrate the theory. A companion website contains these examples worked out as Excel spreadsheets so that readers can input their own data to test the results.
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Graduate students and professors in finance, and professionals working with investment tools such as financial analysts and portfolio managers.


Book information

  • Published: May 2008
  • ISBN: 978-0-12-374356-5


“A mathematical-economist-turned-behavioral-economist, Hersh Shefrin challenges and delights the reader by applying concepts of behavioral economics with emphasis on investor heterogeneity to revisit a broad spectrum of topics in finance including portfolio management, trading, and the pricing of equities, bonds and options.” George M. Constantinides, Leo Melamed Professor of Finance, The University of Chicago Graduate School of Business “The flood of empirical asset pricing research in recent years has often required financial economists to choose between two unpalatable options: either embrace the rich range of evidence with a somewhat atheoretical view; or, simply ignore that large portion of the evidence that conflicts with classical asset pricing theory. The behavioral finance pioneer Hersh Shefrin, in this new edition of his treatise, shows that one need not choose between theory and data. He shows that a number of seemingly "behavioral" patterns in the data can in fact be derived from a suitably modified version of the stochastic discount factor framework. Impressive in both scope and attention to detail, this book will be valuable for researchers, teachers, students, and investment professionals.” Jeffrey Wurgler, Research Professor of Finance, NYU Stern School of Business “Judging from the large volume of trade in the financial markets and the astounding volatility of prices, one has to accept the idea that investors hold divergent and fast fluctuating beliefs. For this to make sense, I see only two possible hypotheses. Both individual and professional investors receive a lot of information — some of it public but a lot more of it private — on which they act. Or they all receive similar information but each one interprets that information somewhat differently from the other. Although it is not quite rational, I find the latter behaviour more plausible than the former. A large part of the second edition of A Behavioral Approach to Asset Pricing is devoted to developing this arresting, although by no means mainstream, hypothesis. In that endeavour, Professor Shefrin is a maverick and a pioneer.” —Bernard Dumas, Professor of Finance, Swiss Finance Institute, Université de Lausanne, Switzerland Praise for the First Edition: “This book provides a much-needed bridge between behavioral finance and traditional asset pricing theory, so that the insights that the two fields offer can complement each other. This book will make the theory of behavioral finance far more useful and broadly applicable.” —Robert Shiller, Cowles Foundation for Research in Economics, International Center for Finance, Yale University

Table of Contents

PrefacePreface to the Second EditionChapter 1- IntroductionI Heuristics and Representativeness: Experimental EvidenceChapter 2- Representativeness and Bayes Rule: Psychological Perspective Chapter 3- Representativeness and Bayes Rule: Economics Perspective Chapter 4- A Simple Asset Pricing Model Featuring Representativeness Chapter 5- Heterogeneous Judgements in Experiments II Heuristics and Representativeness: Investor ExpectationsChapter 6- Representativeness and Heterogeneous Beliefs Among Individual Investors, Financial Executives, and Academics Chapter 7- Representativeness and Heterogeneity in the Judgements of Professional Investors III Developing Behavioral Asset Pricing ModelsChapter 8- A Simple Asset Pricing Model with Heterogeneous Beliefs Chapter 9- Heterogeneous Beliefs and Inefficient Markets Chapter 10- A Simple Market Model of Prices and Trading Volume Chapter 11- Efficiency and Entropy: Long-run Dynamics IV Heterogeneity in Risk Tolerance and Time DiscountingChapter 12- CRRA and CARA Utility Functions Chapter 13- Heterogeneous Risk Tolerance and Time Preference Chapter 14- Representative Investors in a Heterogeneous CRRA ModelIV Sentiment and Behavioral SDF Chapter 15- Sentiment Chapter 16- Behavioral SDF and the Sentiment Premium VI Applications and Behavioral SDFChapter 17- Behavioral Betas and Mean-Variance Portfolios Chapter 18- Cross-section of Return Expectations Chapter 19- Testing for a Sentiment Premium Chapter 20- A Behavioral Approach to the Term Structure of Interest Rates Chapter 21- Behavioral Black-Scholes Chapter 22- Irrational Exuberance and Option Smiles Chapter 23- Empirical Evidence in Support of Behavioral SDF VII Prospect TheoryChapter 24- Prospect Theory: Introduction Chapter 25- Behavioral Portfolios Chapter 26- Equilibrium with Behavioral PreferencesChapter 27- Pricing and Prospect Theory: Empirical Studies Chapter 28- Reflections on the Equity Premium Puzzle Chapter 29- Continuous Time Behavioral Equilibrium ModelsChapter 30 ConclusionReferences