Behavioral Finance Spring 2002

COURSE DESCRIPTION

Behavioral finance is a new field in finance, which has been the subject of an increasing amount of research over the last few years. The field came into prominence in the early part of the 1990s when a number of researchers documented that, contrary to the efficient markets and portfolio theory hypotheses, anomalies could be observed in returns to firms. In the first part of the 1990s, a number of papers documented the existence of anomalies in long-horizon returns to an enormous variety of corporate events - from mergers to share repurchases to stock splits. In the second half, attention turned to either to deriving theoretical models to explain these anomalies or to devising new methodologies that would make these anomalies go away.

This short course should give you a survey of the literature and hopefully, suggest some avenues for further research. In the first session of the course, we will cover the history of the behavioral finance area - what the anomalies are. We will also cover the first approach to resolving these anomalies - attributing them to biases in computing returns. In the second session, we will cover the second theoretical approach - what behavioral models predict. Finally, we will look at a pot-pourri of additional unresolved topics.

Please read the papers in the respective sessions before coming to class. You should be able to download all the papers published in the Journal of Finance from the JStor and the Journal website. Articles from the American Economic Review, the Journal of Political Economy and the Journal of Business are also available from the JStor site. All articles published in the Review of Financial Studies are available from the OUP website (rfs.oupjournals.org). Journal of Financial Economics articles are available from Elsevier at ScienceDirect.com after 1995. Working papers are available on SSRN. Articles which are not available from any of these sources will be given to you. Alternatively, the papers are available here.

COURSE OUTLINE

1. Anomalies in the efficient markets literature (Session 1)

• Fama, E. F., 1970. Efficient capital markets: A review of theory and empirical work. Journal of Finance 25:383-417.
• Dimson, E. and Mussavian, M., 1998. A brief history of market efficiency. European Financial Management 4:91-103.
• De Bondt, W. F. M. and Thaler, R., 1985. Does the stock market overreact? Journal of Finance 40:793-808.
• Ritter, J. R., 1991. The long-run performance of initial public offerings. Journal of Finance 46:3-27.
• Loughran, T. and Ritter, J. R., 1995. The new issues puzzle. Journal of Finance 50:23-51.
• Lakonishok, J., Shleifer, A. and Vishny, R. W., 1994. Contrarian investment, extrapolation, and risk. Journal of Finance 49:1541-1578.
• Ikenberry, D., Lakonishok, J. and Vermaelen, T., 1995. Market underreaction to open market share repurchases. Journal of Financial Economics 39:181-208.
• Rau, P. R. and Vermaelen, T., 1998. Glamour, value and the post-acquisition performance of acquiring firms. Journal of Financial Economics 49:223-253.
• Chan, L. K. C., Jegadeesh, N. and Lakonishok, J., 1995. Evaluating the performance of value versus glamour stocks: The impact of selection bias. Journal of Financial Economics 38:269-296.

2. Resolving the anomalies: Biases in computing returns (Session 1)

• Fama, E. F., 1998. Market efficiency, long-term returns and behavioral finance. Journal of Financial Economics 49:283-306.
• Mitchell, M. L. and Stafford, E., 2000. Managerial decisions and long-term stock performance. Journal of Business 73:287-320.
• Loughran, T. and Ritter, J. R., 2000. Uniformly least powerful tests of market efficiency. Journal of Financial Economics 55:361-389.
• Eckbo, B. E., Masulis, R. W. and Norli, Ø. 2000. Seasoned public offerings: Resolution of the 'new issues puzzle' Journal of Financial Economics 56:251-291.
• Brav, A., 2000. Inference in long-horizon event studies: A Bayesian approach with application to initial public offerings. Journal of Finance 55:1979 - 2016.
• Brav, A. and Gompers, P. A., 1997. Myth or reality? The long-run underperformance of initial public offerings: Evidence from venture and nonventure capital-backed companies. Journal of Finance 52:1791-1822.
• Cooper, M., Gutierrez, R. C., Jr. and Marcum, W., 2001. Is predictability simply hindsight? Journal of Business, forthcoming.
• Jegadeesh, N., 2000. Long-term performance of seasoned equity offerings: Benchmark errors and biases in expectations. Financial Management 29:5-30.

3. Resolving the anomalies: Theoretical models of behavioral finance (Session 2)

• DeLong, J. B., Shleifer, A., Summers, L. H. and Waldmann, R. J. 1993. Noise trader risk in financial markets. Journal of Political Economy 98: 703-738.
• Shleifer, A. and Vishny, R. W. , 1997. The limits of arbitrage. Journal of Finance 52: 35-55.
• Daniel, K., Hirshleifer, D. and Subrahmanyam, A., 1998. Investor psychology and security market under- and over-reactions. Journal of Finance 53:1839-1885.
• Barberis, N., Shleifer, A. and Vishny, R. W., 1998. A model of investor sentiment. Journal of Financial Economics 49:307-343.
• Hong, H. and Stein, J. C., 1999. A unified theory of underreaction, momentum trading and overreaction in asset markets. Journal of Finance 54:2143-2184.
• Barberis, N. and Huang, M., 2001. Mental accounting, loss aversion, and individual stock returns. Journal of Finance 56:1247-1292.

4. Unresolved problems (Session 2)

• Barber, B. M. and Odean, T., 2000. Trading is hazardous to your wealth: The common stock investment performance of individual investors. Journal of Finance 55:773 - 806.
• Hirshleifer, D. A. and Shumway, T. G., 2001. Good day sunshine: Stock returns and the weather. Unpublished working paper. Fisher College of Business, The Ohio State University.
• Kadiyala, P. and Rau, P. R., 2002. Investor reaction to corporate event announcements: Under-reaction or over-reaction? Unpublished working paper. Purdue University.
• Cooper, M. J., Dimitrov, O. and Rau, P. R., 2001. A rose.com by any other name. Journal of Finance 56:2371-2388.
• Rau, P. R., 2001. When is cheap talk valuable? The case of the INSEAD ball ticket market. Unpublished working paper. Purdue University.
• Rashes, M. S., 2001. Massively confused investors making conspicuously ignorant choices (MCI-MCIC). Journal of Finance 56:1911-1927..
• Coval, J. D. and Shumway, T., 2001. Is sound just noise? Journal of Finance 56:1887-1910.
• Huberman, G. and Regev, T., 2001. Contagious speculation and a cure for cancer: A non-event that made stock prices soar. Journal of Finance 56:387-396.