From the field's leading authority, the most authoritative and comprehensive advanced-level textbook on asset pricing
In Financial Decisions and Markets, John Campbell, one of the fields most respected authorities, provides a broad graduate-level overview of asset pricing. He introduces students to leading theories of portfolio choice, their implications for asset prices, and empirical patterns of risk and return in financial markets. Campbell emphasizes the interplay of theory and evidence, as theorists respond to empirical puzzles by developing models with new testable implications. The book shows how models make predictions not only about asset prices but also about investors financial positions, and how they often draw on insights from behavioral economics.
After a careful introduction to single-period models, Campbell develops multiperiod models with time-varying discount rates, reviews the leading approaches to consumption-based asset pricing, and integrates the study of equities and fixed-income securities. He discusses models with heterogeneous agents who use financial markets to share their risks, but also may speculate against one another on the basis of different beliefs or private information. Campbell takes a broad view of the field, linking asset pricing to related areas, including financial econometrics, household finance, and macroeconomics. The textbook works in discrete time throughout, and does not require stochastic calculus. Problems are provided at the end of each chapter to challenge students to develop their understanding of the main issues in financial economics.
The most comprehensive and balanced textbook on asset pricing available, Financial Decisions and Markets is an essential resource for all graduate students and practitioners in finance and related fields.
Integrated treatment of asset pricing theory and empirical evidence
Emphasis on investors decisions
Broad view linking the field to financial econometrics, household finance, and macroeconomics
Topics treated in discrete time, with no requirement for stochastic calculus
Solutions manual for problems available to professors
John Y. Campbell is the Morton L. and Carole S. Olshan Professor of Economics at Harvard University. His books include The Econometrics of Financial Markets (Princeton) and Strategic Asset Allocation: Portfolio Choice for Long-Term Investors.
Figures xiii
Tables xv
Preface xvii
Part I Static Portfolio Choice and Asset Pricing
1 Choice under Uncertainty 3
1.1 Expected Utility 3
1.1.1 Sketch of von Neumann-Morgenstern Theory 4
1.2 Risk Aversion 5
1.2.1 Jensens Inequality and Risk Aversion 5
1.2.2 Comparing Risk Aversion 7
1.2.3 The Arrow-Pratt Approximation 9
1.3 Tractable Utility Functions 10
1.4 Critiques of Expected Utility Theory 12
1.4.1 Allais Paradox 12
1.4.2 Rabin Critique 13
1.4.3 First-Order Risk Aversion and Prospect Theory 14
1.5 Comparing Risks 15
1.5.1 Comparing Risks with the Same Mean 16
1.5.2 Comparing Risks with Different Means 18
1.5.3 The Principle of Diversification 19
1.6 Solution and Further Problems 20
2 Static Portfolio Choice 23
2.1 Choosing Risk Exposure 23
2.1.1 The Principle of Participation 23
2.1.2 A Small Reward for Risk 24
2.1.3 The CARA-Normal Case 25
2.1.4 The CRRA-Lognormal Case 27
2.1.5 The Growth-Optimal Portfolio 30
2.2 Combining Risky Assets 30
2.2.1 Two Risky Assets 31
2.2.2 One Risky and One Safe Asset 33
2.2.3 N Risky Assets 34
2.2.4 The Global Minimum-Variance Portfolio 35
2.2.5 The Mutual Fund Theorem 39
2.2.6 One Riskless Asset and N Risky Assets 39
2.2.7 Practical Difficulties 42
2.3 Solutions and Further Problems 43
3 Static Equilibrium Asset Pricing 47
3.1 The Capital Asset PricingModel (CAPM) 47
3.1.1 Asset Pricing Implications of the Sharpe-Lintner CAPM 48
3.1.2 The Black CAPM 50
3.1.3 Beta Pricing and Portfolio Choice 51
3.1.4 The Black-Litterman Model 54
3.2 Arbitrage Pricing and Multifactor Models 55
3.2.1 Arbitrage Pricing in a Single-Factor Model 55
3.2.2 Multifactor Models 59
3.2.3 The Conditional CAPM as a Multifactor Model 60
3.3 Empirical Evidence 61
3.3.1 Test Methodology 61
3.3.2 The CAPM and the Cross-Section of Stock Returns 66
3.3.3 Alternative Responses to the Evidence 72
3.4 Solution and Further Problems 77
4 The Stochastic Discount Factor 83
4.1 Complete Markets 83
4.1.1 The SDF in a Complete Market 83
4.1.2 The Riskless Asset and Risk-Neutral Probabilities 84
4.1.3 Utility Maximization and the SDF 85
4.1.4 The Growth-Optimal Portfolio and the SDF 85
4.1.5 Solving Portfolio Choice Problems 86
4.1.6 Perfect Risksharing 87
4.1.7 Existence of a Representative Agent 88
4.1.8 Heterogeneous Beliefs 89
4.2 Incomplete Markets 90
4.2.1 Constructing an SDF in the Payoff Space 90
4.2.2 Existence of a Positive SDF 92
4.3 Properties of the SDF 93
4.3.1 Risk Premia and the SDF 93
4.3.2 Volatility Bounds 95
4.3.3 Entropy Bound 100
4.3.4 Factor Structure 102
4.3.5 Time-Series Properties 102
4.4 Generalized Method of Moments 103
4.4.1 Asymptotic Theory 104
4.4.2 Important GMM Estimators 105
4.4.3 Traditional Tests in the GMM Framework 107
4.4.4 GMM in Practice 109
4.5 Limits of Arbitrage 112
4.6 Solutions and Further Problems 114
Part II Intertemporal Portfolio Choice and Asset Pricing
5 Present Value Relations 121
5.1 Market Efficiency 121
5.1.1 Tests of Autocorrelation in Stock Returns 124
5.1.2 Empirical Evidence on Autocorrelation in Stock Returns 125
5.2 Present Value Models with Constant Discount Rates 127
5.2.1 Dividend-Based Models 127
5.2.2 Earnings-Based Models 131
5.2.3 Rational Bubbles 132
5.3 Present Value Models with Time-Varying Discount Rates 134
5.3.1 The Campbell-Shiller Approximation 134
5.3.2 Short-and Long-Term Return Predictability 137
5.3.3 Interpreting US Stock Market History 140
5.3.4 VAR Analysis of Returns 143
5.4 Predictive Return Regressions 1
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