Advances in Behavioral Finance

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Overview

Modern financial markets offer the real world's best approximation to the idealized price auction market envisioned in economic theory. Nevertheless, as the increasingly exquisite and detailed financial data demonstrate, financial markets often fail to behave as they should if trading were truly dominated by the fully rational investors that populate financial theories.

These markets anomalies have spawned a new approach to finance, one which as editor Richard Thaler puts it, "entertains the possibility that some agents in the economy behave less than fully rationally some of the time." Advances in Behavioral Finance collects together twenty-one recent articles that illustrate the power of this approach. These papers demonstrate how specific departures from fully rational decision making by individual market agents can provide explanations of otherwise puzzling market phenomena.

To take several examples, Werner De Bondt and Thaler find an explanation for superior price performance of firms with poor recent earnings histories in the tendencies of investors to overreact to recent information. Richard Roll traces the negative effects of corporate takeovers on the stock prices of the acquiring firms to the overconfidence of managers, who fail to recognize the contributions of chance to their past successes. Andrei Shleifer and Robert Vishny show how the difficulty of establishing a reliable reputation for correctly assessing the value of long term capital projects can lead investment analysis, and hence corporate managers, to focus myopically on short term returns.

As a testing ground for assessing the empirical accuracy of behavioral theories, the successful studies in this landmark collection reach beyond the world of finance to suggest, very powerfully, the importance of pursuing behavioral approaches to other areas of economic life. Advances in Behavioral Finance is a solid beachhead for behavioral work in the financial arena and a clear promise of wider application for behavioral economics in the future.

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Editorial Reviews

Booknews
A collection of 21 recent articles that illustrate the power of a new approach to finance, one which as editor Thaler puts it, "entertains the possibility that some of the agents in the economy behave less than fully rationally some of the time." These papers illustrate how specific departures from fully rational decisionmaking by individual market agents can provide explanations of otherwise puzzling market phenomena. Annotation c. Book News, Inc., Portland, OR (booknews.com)
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Product Details

Meet the Author

RICHARD H. THALER is Henrietta Johnson Louis Professor of Economics, and director of the Center for Behavioral Economics and Decision Research, Johnson Graduate School of Management, Cornell University.

CONTRIBUTORS: Lawrence M. Ausubel, Victor L. Bernard, Fischer Black, Navin Chopra, David M. Cutler, Werner F. M. De Bondt, J. Bradford De Long, Jeffrey A. Frankel, Kenneth R. French, Kenneth A. Froot, Josef Lakonishok, Charles M. C. Lee, James M. Poterba, Jay R. Ritter, Richard Roll, Hersh M. Shefrin, Robert J. Shiller, Andrei Shleifer, Meir Statman, Jeremy Stein, Lawrence H. Summers, Richard H. Thaler, Robert W. Vishny, and Robert J. Waldmann

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Table of Contents

Preface
Ch. 1 A survey of behavioral finance 1
Ch. 2 The limits of arbitrage 79
Ch. 3 How are stock prices affected by the location of trade? 102
Ch. 4 Can the market add and subtract? : mispricing in tech stock carve-outs 130
Ch. 5 Valuation ratios and the long-run stock market outlook : an update 173
Ch. 6 Myopic loss aversion and the equity premium puzzle 202
Ch. 7 Prospect theory and asset prices 224
Ch. 8 Contrarian investment, extrapolation, and risk 273
Ch. 9 Evidence on the characteristics of cross-sectional variation in stock returns 317
Ch. 10 Momentum 353
Ch. 11 Market efficiency and biases in brokerage recommendations 389
Ch. 12 A model of investor sentiment 423
Ch. 13 Investor psychology and security market under- and overreaction 460
Ch. 14 A unified theory of underreaction, momentum trading, and overreaction in asset markets 502
Ch. 15 Individual investors 543
Ch. 16 Naive diversification strategies in defined contribution savings plans 570
Ch. 17 Rational capital budgeting in an irrational world 605
Ch. 18 Earnings management to exceed thresholds 633
Ch. 19 Managerial optimism and corporate finance 667
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