Description
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.

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. In this 2nd Edition Hersh Shefrin examines the reigning assumptions of asset pricing theory and reconstructs them to incorporate findings from behavioral finance. In other words, he takes the traditional tools in asset pricing and behavioralizes them. He constructs a solid, intact structure that challenges classic assumptions and at the same time provides a strong theory and efficient empirical tools. Building on the models developed by both traditional asset pricing theorists and behavioral asset pricing theorists, Shefrin's book takes the discussion to the next step. He provides a general behaviorally based intertemporal treatment of asset pricing theory that extends to the discussion of derivatives, fixed income securities, mean-variance efficient portfolios, and the market portfolio, based on all the latest research and theory. * The second edition continues the tradition of the first edition by being the one and only book to focus completely on how behavioral finance principles affect asset pricing, now with its theory deepened and enriched by a plethora of research since the first edition * A companion website contains a series of examples worked out as Excel spreadsheets so that readers can input their own data to test the results.

Table of Contents

1 Introduction 1

I Heuristics and representativeness : experimental evidence 15

2 Representativeness and Bayes rule : psychological perspective 17

3 Representativeness and Bayes rule : economics perspective 27

4 A simple asset pricing model featuring representativeness 35

5 Heterogeneous judgments in experiments 47

II Heuristics and representativeness : investor expectations 63

6 Representativeness and heterogeneous beliefs among individual investors, financial executives, and academics 65

7 Representativeness and heterogeneity in the judgments of professional investors 79

III Developing behavioral asset pricing models 101

8 A simple asset pricing model with heterogeneous beliefs 103

9 Heterogeneous beliefs and inefficient markets 115

10 A simple market model of prices and trading volume 131

11 Efficiency and entropy : long-run dynamics 149

IV Heterogeneity in risk tolerance and time discounting 167

12 CRRA and CARA utility functions 169

13 Heterogeneous risk tolerance and time preference 183

14 Representative investors in a heterogeneous CRRA model 193

V Sentiment and behavioral SDF 211

15 Sentiment 213

16 Behavioral SDF and the sentiment premium 231

VI Applications of behavioral SDF 249

17 Behavioral betas and mean-variance portfolios 251

18 Cross-section of return expectations 269

19 Testing for a sentiment premium 295

20 A behavioral approach to the term structure of interest rates 305

21 Behavioral Black-Scholes 317

22 Irrational exuberance and option smiles 337

23 Empirical evidence in support of behavioral SDF 359

VII Behavioral preferences 389

24 Prospect theory : introduction 391

25 Prospecttheory portfolios 419

26 SP/A theory : introduction 429

27 SP/A-based behavioral portfolio theory 437

28 Equilibrium with behavioral preferences 461

29 The disposition effect : trading behavior and pricing 487

30 Reflections on the equity premium puzzle 505

VIII Future directions and closing comments 523

31 Continuous time behavioral equilibrium models 525

32 Conclusion 551

References 563

Index 587