Behavioral Finance
Economics 970
Brandon Adams, Teaching Fellow
badams@hbs.edu
(850) 232-7856
Location: TBA
Time: TBA
Course Description:
Behavioral finance argues that many facts about asset prices, investor behavior, and managerial
behavior are best understood in models where at least some agents are not fully rational. This
course will start by working through several survey articles that will give students a feel for the
different strands of behavioral finance research.
The first section of the course will cover limits to arbitrage. Efficient markets theory argues that
smart investors will quickly reverse any dislocations caused by irrational investors. The theory of
limits to arbitrage suggests a number of reasons why this might not be the case. We will spend a
total of five classes going over the theory and evidence related to limits to arbitrage, and then we
will spend a sixth class discussing the Dotcom bubble, since that time period provides great
examples of limits to arbitrage at work.
The second section of the course looks at persistent decision-making biases that have been
documented by psychologists. Much of behavioral finance consists of theorists making
predictions about asset pricing given that at least some investors have one or more of these
decision-making biases.
The third section covers investor behavior, and the fourth section covers behavioral corporate
finance. Miscellaneous topics such as IPOs, agency problems in investment management, and the
performance of investment managers, will be interspersed throughout the semester.
The course will feature extensive discussion of recent events such as LTCM, the dotcom bubble,
and Enron. The last five years have provided ample demonstration of the concepts of behavioral
finance, and have led in no small part to behavioral finance becoming the mainstream within the
profession.
Course Requirements:
Class Participation: 35% of grade. Attendance is mandatory.
Short Papers. 20% of grade. Two short papers (6-8 pages, double-spaced). One of the papers
will be a literature summary of one of the major strands of behavioral finance. The other paper
will be either: a short empirical study of a behavioral finance phenomena of interest, or a short
paper relating behavioral finance theory to an event in US financial history.
Empirical Paper. 15% of grade. This paper will require you to conduct statistical tests on a
phenomena of interest and report the results. It will be expected that your statistical tests are well
motivated by theory.
Final Paper. 30%. 12-16 pages, double-spaced. You will be given several different options for
your final paper. It can be expected that all of the options will involve some data work.
Course Policies:
Attendance. Attendance is mandatory at all regular class meetings. Exceptions for personal or
family emergencies will be granted on a case-by-case basis.
Tardiness. No assignment will be accepted beyond the announced deadline. As with attendance,
exceptions for personal or family emergencies will be made on a case-by-case basis.
Office hours. I will be available for office hours for 30 minutes after every class. If additional
time is needed, please email me at badams@hbs.edu.
Required Text:
Inefficient Markets: An Introduction to Behavioral Finance. Andrei Shleifer.
Recommended Texts:
A Random Walk Down Wall Street. Burton Malkiel. 1999.
The Winner’s Curse. Richard Thaler.
Assignment Schedule:
Short Paper #1
Short Paper #2
Empirical Paper
Final Paper
Date Discussed in Class
Class 4
Class 14
Class 6
Class 11
Due Date
Class 7
Class 18
Class 16
Class 22
Readings:
There will not be a coursepack for this course. I will send out an electronic version of the
syllabus that will contain web links to most of the papers covered. Every week, I will send out an
email that will have links to all of the papers covered. Students will be expected to print out these
papers. They will never be asked to photocopy articles from a journal or book. Sometimes I will
provide photocopies of the readings to be covered a couple of classes in advance. Throughout the
semester, I will give out detailed lists of supplementary readings that the student can keep for
future reference.

* denotes required reading. Other readings are recommended.
Course Schedule:
1. Overview of Behavioral Finance
Reading: *“A Survey of Behavioral Finance”. Nicholas Barberis, Richard Thaler. 2001.
http://www.courses.fas.harvard.edu/~ec2728/Papers/Barberis_Thaler_2001.pdf
There is a close correspondence between this survey and the syllabus that Prof.
Barberis uses for his behavioral finance course at UChicago.
http://gsbwww.uchicago.edu/fac/nicholas.barberis/teaching/
Barberis’ syllabus provides the best behavioral finance reading list I have seen.
Another good one is available at…
http://www.business.city.ac.uk/ferc//mark/teach/behavioural/behavioural2001.pdf
An excellent set of lecture notes on behavioral finance can be found at…
http://frankschmid.com/bf.htm
2. Overview of Behavioral Finance (cont.)
*David Hirshleifer. “Investor Psychology and Asset Pricing”. 2001.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=265132
This is another survey of behavioral finance. It complements the
Barberis/ Thaler article nicely. Barberis and Thaler provide a broad
overview of the field, while Hirshleifer focuses on investor psychology.
Background:
Inefficient Markets. Andrei Shleifer. Ch. 1
The Winner’s Curse. Richard Thaler. Chapters 10-14.
Against the Gods: The Remarkable Story of Risk. Peter
Bernstein. Ch 16,17,19.
3. Overview of Behavioral Finance (cont.)
*Eugene Fama. Market Efficiency, Long-Term Returns, and Behavioral
Finance.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=15108
Rubinstein, Mark (2001), “Rational Markets: Yes or No? The
Affirmative Case,” Financial Analysts Journal (May-June), 15-29.
4. Limits to Arbitrage: Theory
Survey, pp. 2-8.
Inefficient Markets, Ch. 2, 4.
*Shleifer, Andrei, and Robert Vishny (1997), “The Limits of Arbitrage,”
Journal of Finance 52, 35-55 [covered in Inefficient Markets, Ch .4]
5. Limits to Arbitrage: Theory (cont.)
Inefficient Markets, Ch. 2, 4.
*DeLong, J. Bradford, Andrei Shleifer, Lawrence H. Summers, and
Robert Waldmann, "Noise Trader Risk in Financial Markets," Journal of
Political Economy 98, 703-738 [in Advances, Ch.2, also covered in
Inefficient Markets, Ch.2.]
6. Limits to Arbitrage: Evidence
Survey, pp. 8-11.
Lamont, Owen, and Richard Thaler (2003), “Can the Market Add and
Subtract? Mispricing in Tech Stock Carve-Outs,” forthcoming, Journal
of Political Economy [available on Lamont’s GSB web site]
*Mitchell, Mark, Todd Pulvino, and Erik Stafford (2002), “Limited
Arbitrage in Equity Markets,” Journal of Finance 57, 551-584 [available
on Pulvino’s web site at the Kellogg School of Management].
7. Limits to Arbitrage: Evidence (cont.)
Shleifer, Andrei (1986), “Do Demand Curves for Stocks Slope Down?,”
Journal of Finance 41, 579-90.
*Wurgler, Jeffrey, and Katya Zhuravskaya (2002), “Does Arbitrage
Flatten Demand Curves for Stocks?,” Journal of Business 75, 583-608.
8.
Short-Sal e Constraints
*“The Market for Borrowing Stock”. Gene D’Avolio.
http://www.courses.fas.harvard.edu/~ec2728/Papers/Davolio_2001.pdf
“The Expiry of IPO Share Lock-Ups”. 2001. Laura Field, Gordon Hanka.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=205011
9. Discussion of the Dotcom Bubble
*“The Dotcom Bubble: The Rise and Fall of Internet Stock Prices”. Eli Ofek,
Matt Richardson
http://www.courses.fas.harvard.edu/~ec2728/Papers/Ofek_Richardson_2002.pdf
Related Material: Dotcon: The Greatest Story Ever Sold. John Cassidy
Devil Take the Hindmost. Edward Chancellor. Ch 8, 9,
Inefficient Markets. Shleifer, Ch 2.
Irrational Exuberance. Robert Shiller.
10. Agency Problems in Investment Management. Hedge Fund Performance.
Reading:
Inefficient Markets. Andrei Shleifer. Ch 4.
*“How the Eggheads Cracked” Michael Lewis
http://www.magnum.com/hedgefunds/articles/1999/990124hfprint.asp
Related Material: “On Taking the ‘Alternative’ Route: Risks, Rewards, Style, and
Performance Persistence of Hedge Funds”. Vikas Agarwal, Narayan Naik.
http://papers.ssrn.com/sol3/delivery.cfm/99022311.pdf?abstract_id=150388
A Powerpoint presentation on this paper is available at…
http://mba.vanderbilt.edu/fmrc/Activity/Conference%20Presentations/Agarwalvanderbilt%20apr2002.ppt
“Offshore Hedge Funds: Survival and Performance 1989-1995”. Steven Brown,
William Goetzman, Roger Ibbotson.
http://papers.nber.org/papers/W5909
When Genius Failed. Roger Lowenstein.
11.
IPOs
*“A Review of IPO Activity, Pricing, and Allocations”. 2002. Jay Ritter, Ivo
Welch
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=296393
12.
Khaneman and Tversky
Kahneman, Daniel, and Amos Tversky (1974), “Judgment Under
Uncertainty: Heuristics and Biases,” Science 185, 1124-31.
*Kahneman, Daniel, and Amos Tversky (1979), “Prospect Theory: An
Analysis of Decision Under Risk,” Econometrica 47, 263-91.
Kahneman, Daniel, and Mark Riepe (1998), “Aspects of Investor
Psychology,” Journal of Portfolio Management 24, 52-65.
13. Investor Psychology
*Benartzi, Shlomo, and Richard Thaler (1995), “Myopic Loss Aversion
and the Equity Premium Puzzle,” Quarterly Journal of Economics 110,
75-92.
*Thaler, Richard, and Eric Johnson (1985), “Gambling with the House
Money and Trying to Break Even: The Effects of Prior Outcomes on
Risky Choice,” Management Science 36, 643-660.
14. Overreaction and Momentum
*Jegadeesh, Narasimhan and Sheridan Titman (1993), “Returns to
Buying Winners and Selling Losers: Implications for Stock Market
Efficiency,” Journal of Finance 48, 65-91.
*De Bondt, Werner, and Richard Thaler (1985), “Does the Stock Market
Overreact?,” Journal of Finance 40, 793-808 [in Advances, Ch.9].
15. Shleifer vs. Fama
*Lakonishok, Josef, Andrei Shleifer, and Robert W. Vishny (1994),
“Contrarian Investment, Extrapolation, and Risk,” Journal of Finance
49, 1541-1578.
Barberis, Nicholas, Andrei Shleifer, and Robert Vishny (1998), “A
Model of Investor Sentiment,” Journal of Financial Economics 49, 307345 [in Inefficient Markets, Ch.5].
Fama, Eugene F. (1998), “Market Efficiency, Long-Term Returns, and
Behavioral Finance,” Journal of Financial Economics 49, 283-307.
16. Investor Behavior
Survey, pp. 47-52.
*Barber, Brad, and Terrance Odean (2000), “Trading is Hazardous to
Your Wealth: The Common Stock Investment Performance of Individual
Investors,” Journal of Finance 55, 773-806 [available on Odean’s UC
Berkeley web site].
*Barber, Brad, and Terrance Odean (2002), “Online Investors: Do the
Slow Die First?,” Review of Financial Studies 15, 455-487.
Barber, Brad, and Terrance Odean (2001), “All that Glitters: the Effect of
Attention on the Buying Behavior of Individual and Institutional Investors,”
Working paper, UC Berkeley [available on Odean’s UC Berkeley web site].
17. Investor Behavior (cont.)
Grinblatt, Mark and Bin Han (2002), “The Disposition Effect and
Momentum,” Working paper, Anderson School, UCLA.
*Odean, Terrance (1998), “Are Investors Reluctant to Realize their
Losses,” Journal of Finance 53, 1775-1798.
*Odean, Terrance (1998), “Do Investors Trade Too Much?,” American
Economic Review 89, 1279-1298.
18. Behavioral Corporate Finance
*Baker, Malcolm, Jeremy Stein, and Jeffrey Wurgler (2001), “When
Does the Market Matter? Stock Prices and the Investment of EquityDependent Firms,” forthcoming, Quarterly Journal of Economics
[available on Wurgler’s web site at NYU].
Baker, Malcolm, and Jeffrey Wurgler (2000), “The Equity Share in New
Issues and Aggregate Stock Returns,” Journal of Finance 55, 2219-2257.
19. Behavioral Corporate Finance (cont.)
*Baker, Malcolm, and Jeffrey Wurgler (2002), “Market Timing and
Capital Structure,” Journal of Finance 57, 1-32 [available on Wurgler’s
web site at NYU].
Baker, Malcolm, and Jeffrey Wurgler (2002), “A Catering Theory of
Dividends,” Working paper, NYU [available on Wurgler’s web site at
NYU].
20. Behavioral Corporate Finance (cont.)
*Morck, Randall, Andrei Shleifer, and Robert Vishny (1993), “The
Stock Market and Investment: Is the Market a Sideshow?,” Brookings
Papers on Economic Activity.
Shleifer, Andrei, and Robert Vishny (2003), “Stock Market Driven
Acquisitions,” forthcoming, Journal of Financial Economics.
21. Short-selling and Returns
Hong, Harrison, and Jeremy Stein (1999), “Differences of Opinion,
Short-sales Constraints and Market Crashes,” forthcoming, Review of
Financial Studies.
*Jones, Charles, and Owen Lamont (2001), “Short Sale Constraints and
Stock Returns,” Journal of Financial Economics 66, 207-239 [available
on Lamont’s GSB web site].
Miller, Edward (1977), “Risk, Uncertainty and Divergence of Opinion,”
Journal of Finance 32, 1151-1168.
22. Value vs. Growth
Fama, Eugene F. and Kenneth R. French (1992), “The Cross-Section of
Expected Stock Returns,” Journal of Finance 47, 427-465.
*“Earnings Surprises, Growth Expectations, and Stock Returns: Don’t Let an
Earnings Torpedo Sink Your Portfolio”. Douglas Skinner, Richard Sloan.