A Behavioral Approach to Asset Pricing

Hersh Shefrin holds the Mario L. Belotti Chair in the Department of Finance at Santa Clara University's Leavey School of Business. He is a pioneer of behavioral finance, and has worked on behavioral issues for over thirty years. A Behavioral Approach to Asset Pricing is the first behavioral treatment of the pricing kernel. His book Behavioral Corporate Finance is the first textbook dedicated to the application of behavioral concepts to corporate finance. His book Beyond Greed and Fear was the first comprehensive treatment of the field of behavioral finance. A 2003 article appearing in The American Economic Review included him among the top fifteen theorists to have influenced empirical work in microeonomics. One of his articles is among the all time top ten papers to be downloaded from SSRN. He holds a Ph.D. from the London School of Economics, and an honorary doctorate from the University of Oulu in Finland.

"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, SwitzerlandPraise 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

• 1. IntroductionI Heuristics and Representativeness: Experimental Evidence2. Representativeness and Bayes Rule: Psychological Perspective 3. Representativeness and Bayes Rule: Economics Perspective 4. A Simple Asset Pricing Model Featuring Representativeness 5. Heterogeneous Judgements in Experiments II Heuristics and Representativeness: Investor Expectations6. Representativeness and Heterogeneous Beliefs Among Individual Investors, Financial Executives, and Academics 7. Representativeness and Heterogeneity in the Judgements of Professional Investors III Developing Behavioral Asset Pricing Models8. A Simple Asset Pricing Model with Heterogeneous Beliefs 9. Heterogeneous Beliefs and Inefficient Markets 10. A Simple Market Model of Prices and Trading Volume 11. Efficiency and Entropy: Long-run Dynamics IV Heterogeneity in Risk Tolerance and Time Discounting12. CRRA and CARA Utility Functions 13. Heterogeneous Risk Tolerance and Time Preference 14. Representative Investors in a Heterogeneous CRRA ModelIV Sentiment and Behavioral SDF 15. Sentiment 16. Behavioral SDF and the Sentiment Premium VI Applications and Behavioral SDF17. Behavioral Betas and Mean-Variance Portfolios 18. Cross-section of Return Expectations 19. Testing for a Sentiment Premium 20. A Behavioral Approach to the Term Structure of Interest Rates 21. Behavioral Black-Scholes 22. Irrational Exuberance and Option Smiles 23. Empirical Evidence in Support of Behavioral SDF VII Prospect Theory24. Prospect Theory: Introduction 25. Behavioral Portfolios 26. Equilibrium with Behavioral Preferences27. Pricing and Prospect Theory: Empirical Studies 28. Reflections on the Equity Premium Puzzle 29. Continuous Time Behavioral Equilibrium Models30. Conclusion