A Behavioral Approach to Asset Pricing or Superior Supervision

A Behavioral Approach to Asset Pricing

Author: Hersh Shefrin

"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 itprivate — 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

Incorporating the latest theory and empirical research, the second edition of A Behavioral Approach to Asset Pricing provides the most up-to-date and comprehensive discussion of how psychology affects market activity. The key message remains: that the future of asset pricing theory lies in bringing together the powerful SDF-based tools adopted by neoclassical asset pricing theorists and the more realistic assumptions adopted by behavioral asset pricing theorists. The most important equation in the first edition is the decomposition of the log-SDF into sentiment and a fundamental component. In the second edition, Shefrin extends the analysis to demonstrate how this equation can be generalized to encompass the combination of behavioral preferences and behavioral beliefs. This generalization provides a unified approach that ties together the main ideas in the book.

The book is supported by a companion website, which contains examples worked out as Excel spreadsheets so that readers can input their own data to test the results.

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

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

Look this: Dining at the Governors Mansion or Betty Crocker PocketChef Quick Dinner 1

Superior Supervision: The Ten Percent Solution: The 10% Solution

Author: Raymond O Loen

Of all the supervisors in all the offices, plants, and organizations in the world, only a small group are truly outstanding at their jobs. Another small group are failures in their work, but the vast majority of supervisors are simply average performers. In Superior Supervision, Raymond O. Loen clearly identifies how supervisors can boost themselves into the top 10% of all supervisors and how they can avoid falling to the ranks of the bottom 10%. For each of the twelve essential components of any supervisor's job - from hiring and training new employees to setting priorities, delegating authority, giving instructions, motivating employees, and engendering cooperation - Loen identifies specific actions that will enable a supervisor to excel. He also spells out the mistakes and oversights that will cause a supervisor to fail. Questions and self-evaluations help readers to assess their supervisory strengths and weaknesses. Clear advice and rich examples guide them towards being a better boss. In this era of employee empowerment and organizational flattening, a supervisor's job is more complex and more important to the organization's success than ever before. With increasing responsibility for decisions, personnel, productivity, quality, sales, and profits, supervisors and their employers can no longer afford lackluster performance. Both new and experienced supervisors will benefit from Loen's advice as they are shown how to optimize their performance, get results, create support from employees and managers, and solve problems. In recognition of supervisors' greater authority and responsibility, Loen even offers a chapter on handling pressure. This book will enable any supervisor to excel more and fail less.

Publishers Weekly

Loen ( Manage More by Doing Less ) notes that supervising employees is a critically important, but generally little understood managerial task. Here he outlines 14 strategies and procedures supervisors can follow ``to perform in the upper ten percent of supervisory performance.'' He sees the supervisory position as an often underutilized opportunity for supervisors to counsel employees, and he adds a list of early warning signs often displayed by employees with a pressing need for counseling, along with intercession techniques. In covering motivation and staffing arrangements, he observes that ``one of the worst hiring practices is to make hiring decisions based primarily on the results of daisy-chain interviewing'' after which executives vote on whom to hire. His discussion of cooperation, instruction and improving worker performance is uninspired, a repackaging of familiar concepts. (Feb.)