Finance and the Behavioral Prospect

1. Front Matter

   Pages i-xii

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2. The Structure of a Behavioral Revolution

   • James Ming Chen

   Pages 1-28

3. Mental Accounting, Emotional Hierarchies, and Behavioral Heuristics

   • James Ming Chen

   Pages 29-56

4. Higher-Moment Capital Asset Pricing and Its Behavioral Implications

   • James Ming Chen

   Pages 57-71

5. Tracking the Low-Volatility Anomaly Across Behavioral Space

   • James Ming Chen

   Pages 73-92

6. The Intertemporal Capital Asset Pricing Model: Hedging Investment Risk Across Time

   • James Ming Chen

   Pages 93-109

7. Risk Aversion

   • James Ming Chen

   Pages 111-135

8. The Equity Risk Premium and the Equity Premium Puzzle

   • James Ming Chen

   Pages 137-179

9. Prospect Theory

   • James Ming Chen

   Pages 181-212

10. Specific Applications of Prospect Theory to Behavioral Finance

    • James Ming Chen

    Pages 213-246

11. Beyond Hope and Fear:Behavioral Portfolio Theory

    • James Ming Chen

    Pages 247-281

12. Behavioral Gaps Between Hypothetical Investment Returns and Actual Investor Returns

    • James Ming Chen

    Pages 283-299

13. Irrational Exuberance: Momentum Crashes and Speculative Bubbles

    • James Ming Chen

    Pages 301-322

14. The Monster and the Sleeping Queen

    • James Ming Chen

    Pages 323-326

15. Back Matter

    Pages 327-343

    PDF

This book explains how investor behavior, from mental accounting to the combustible interplay of hope and fear, affects financial economics. The transformation of portfolio theory begins with the identification of anomalies. Gaps in perception and behavioral departures from rationality spur momentum, irrational exuberance, and speculative bubbles. Behavioral accounting undermines the rational premises of mathematical finance. Assets and portfolios are imbued with “affect.” Positive and negative emotions warp investment decisions. Whether hedging against intertemporal changes in their ability to bear risk or climbing a psychological hierarchy of needs, investors arrange their portfolios and financial affairs according to emotions and perceptions. Risk aversion and life-cycle theories of consumption provide possible solutions to the equity premium puzzle, an iconic financial mystery. Prospect theory has questioned the cogency of the efficient capital markets hypothesis. Behavioral portfolio theory arises from a psychological account of security, potential, and aspiration.

• postmodern portfolio theory
• mathematical finance
• risk seeking
• risk aversion
• VAR
• value-at-risk
• equity premium

“Ever since the early 80s, when Kahneman, Tversky, Thaler, Shiller, and few others started their inquiries into the behavioral side of markets, traditional financial approaches have struggled to keep pace in order to provide useful tools for explanation and prediction.  This book not only synthesizes and critically discusses various behavioral observations and competing theories in a well-structured and reflective manner, but also pushes the field further by suggesting new avenues for its conceptualisation and demonstrating corresponding mathematical methods in various practical applications. An excellent read that provides great value to both practitioners and academics.” (Othmar M Lehner, Full Professor of Finance and Risk at the University of Applied Sciences Upper Austria; Director of the ACRN Oxford Research Centre, United Kingdom)

• College of Law, Michigan State University, East Lansing, USA

  James Ming Chen

James Ming Chen holds the Justin Smith Morrill Chair in Law at Michigan State University, USA. He teaches, lectures, and writes widely on law, economics, and regulation. His books, Disaster Law and Policy and Postmodern Portfolio Theory, cover a broad range of issues concerning extreme events and risk management, from natural to financial disasters. He is of counsel to the Technology Law Group of Washington, D.C.; a public member of the Administrative Conference of the United States; and an elected member of the American Law Institute. A magna cum laude graduate of Harvard Law School and a former editor of the Harvard Law Review, Chen also served as a clerk to Justice Clarence Thomas of the Supreme Court of the United States.

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