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BEHAVIORAL FINANCE AND ASSET MANAGEMENT
Academic Year 2012
Instructor(s): Professor Harrison Hong
Format: 15 hours (3 days) of lectures and discussion
COURSE DESCRIPTION
This course covers recent advances in the field of behavioral finance, with particular attention to the
economics of speculative bubbles and financial crises. Part I introduces market efficiency and tests of
efficiency, with an emphasis on natural experiments. Part II analyzes the effects of increasing I.Q. in
financial markets on asset prices and the potentially destabilizing influence of sophisticated
arbitrageurs. This section also examines the relationship between compensation and the risk of
finance firms in the context of the recent banking crisis. Part III presents a model of asset price
bubbles based on disagreement (or divergence of opinion) among investors and short-sales
constraints that can account for key stylized facts related to trading volume and asset price bubble
dynamics. This model can explain in a unified manner both equity and credit bubbles. We will also
incorporate this speculation due to disagreement into a multi-period Capital Asset Pricing Model
(CAPM) setting and obtain radically different implications from the CAPM, in which low risk assets
obtain high expected returns. Part IV describes how these building blocks can be used to develop real
implications of mis-pricings for corporate decisions such as capital structure, investments and financial
innovations. Part V examines the role of networks, social influences and status effects in generating
slow diffusion of information and in magnifying bubbles and crises.
TEXTBOOKS AND ADDITIONAL READINGS
• Required (distributed)
Lectures Slides
• Recommended:
Inefficient Markets---An Introduction to Behavioral Finance
Author: Andrei Shleifer
Publisher: Cambridge University Press
• Additional readings will be assigned and provided as the course progresses. My papers can be
downloaded from www.princeton.edu/~hhong. The remaining papers can be downloaded from
www.jstor.org, the websites of the various journals, or http://fisher.osu.edu/fin/findir/, where you
can retrieve articles from the websites of other authors.
COURSE OUTLINE AND ASSIGNED READINGS
This is a tentative course outline. Readings will be assigned as the course progresses. The following
abbreviations are used for chapter references in this section: BKM = Investments (Bodie, Kane and
Marcus).
Part I. Market Efficiency and Natural Experiments
Summers, Lawrence H., 1985, “On economics and finance,” Journal of Finance 40, 633-635.
Summers, Lawrence H., 1986, “Does the stock market rationally reflect fundamental values?” Journal
of Finance 41, 591-601.
DeLong, J. Bradford, Andrei Shleifer, Lawrence H. Summers and Robert Waldmann, 1990, “Noise
trader risk in financial markets,” Journal of Political Economy 98, 703-738.
Bernard, Victor, 1992, “Stock price reactions to earnings announcements,” in Richard Thaler (ed.)
Advances in Behavioral Finance. New York, Russell Sage Foundation.
DeBondt, Werner F., and Richard Thaler, 1985, “Does the stock market overreact?” Journal of
Finance 40, 793-805.
Fama, Eugene and Ken French, 1998, “Value versus growth: The international evidence," Journal of
Finance 53, 1975-1999.
Jegadeesh, N. and Sheridan Titman, 1993, “Returns to buying winners and selling losers: Implications
for stock market efficiency,” Journal of Finance 48, 65-91.
Lakonishok, Josef, Andrei Shleifer and Robert W. Vishny, 1994, “Contrarian investment, extrapolation
and risk,” Journal of Finance 49, 1541-1578.
Rules and Regression Discontinuities in Asset Markets, (with Yen-cheng Chang, Shanghai Advanced
Institute for Finance), Princeton University Working Paper, April 2011. (available on
www.princeton.edu/~hhong)
Part II Are Smarter Markets Better Markets?
Hong, Harrison and Jeremy C. Stein, 1999, “A unified theory of underreaction, momentum trading and
overreaction in asset markets,” Journal of Finance 54, 2143-2184.
Hong, Harrison, Terence Lim and Jeremy C. Stein, 2000, “Bad news travels slowly: Size, analyst
coverage and the profitability of momentum strategies,” Journal of Finance 55, 265-295.
Stein, Jeremy C., 1989, “Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate
Behavior,” Quaterly Journal of Economics, 104, 655-669.
Cheng, Ing-Haw, Harrison Hong and Jose Scheinkman, 2009, “Yesterday’s Heroes: Compensation
and Creative Risk-Taking,” Princeton University Working Paper. (available on
www.princeton.edu/~hhong)
Chevalier, Judy and Glenn Ellison, 1999, “Career concerns of mutual fund managers,” Quarterly
Journal of Economics 114, 389-432.
Hong, Harrison, Jeffrey D. Kubik and Amit Solomon, 2000, “Security analysts’ career concerns and
herding of earnings forecasts,” Rand Journal of Economics 31, 121-144.
Scharfstein, David and Jeremy C. Stein, 1990, “Herd behavior and investment,” American Economic
Review 80, 465-479.
Shleifer, Andrei and Robert W. Vishny, 1997, “The limits of arbitrage,” Journal of Finance 52, 35-55.
"Do Arbitrageurs Amplify Economic Shocks?" (w/ Tal Fishman, Princeton University and Jeffrey Kubik,
Syracuse University), forthcoming Journal of Financial Economics, January 2011.
Part III Disagreement Finance
Hong, Harrison and Jeremy C. Stein, 2007, “Disagreement and the Stock Market,” Journal of
Economic Perspectives, Spring.
Odean, Terrance, 1999, Do Investors Trade Too Much?, American Economic Review 89, 1279-1298.
Chen, Joseph, Harrison Hong and Jeremy C. Stein, 2002, “Breadth of ownership and stock returns,”
Journal of Financial Economics 66, 171-205.
Hong, Harrison, Jose Scheinkman and Wei Xiong, 2006, “Asset float and speculative bubbles,”
Journal of Finance 61, 1073-1117.
Hong, Harrison and David Sraer, 2011, “Quiet Bubbles,” Princeton University Working Paper.
(available on www.princeton.edu/~hhong)
Hong, Harrison and David Sraer, 2011, “Speculative Betas,” Princeton University Working Paper.
(available on www.princeton.edu/~hhong)
Part IV. Implications of Mispricings
Stein, Jeremy, 1996, Rational capital budgeting in an irrational world, Journal of Business 69, 429-
455.
Baker, Malcolm, Jeremy Stein and Jeffrey Wurgler, 2003, When does the market matter? Stock prices
and the investment of equity-dependent firms, Quarterly Journal of Economics 118, 969-1005.
Baker, Malcolm and Jeffrey Wurgler, 2002, Market timing and capital structure, Journal of Finance 57,
1-32.
"Firms as Buyers of Last Resort" (w/ Jialin Yu, Columbia University and Jiang Wang, MIT), Journal of
Financial Economics, April 2008. (available on www.princeton.edu/~hhong)
Part V. Social Finance
Hong, Dong, Harrison Hong and Andrei Ungureanu, 2010, “An Epidemiological Approach to Opinion
and Price-Volume Dynamics,” Princeton University Working Paper. (available on
www.princeton.edu/~hhong)
Hong, Harrison, Jeffrey D. Kubik and Jeremy C. Stein, 2005, “Thy Neighbor’s Portfolio: Word-of-Mouth
Effects in the Holdings and Trades of Money Managers,” Journal of Finance 60, 2801-2824.
Hong, Harrison, Jeffrey D. Kubik and Jeremy C. Stein, 2004, “Social Interaction and Stock Market
Participation,” Journal of Finance 59, 137-163.
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