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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.

Finance and the Behavioral Prospect: Risk, Exuberance, and Abnormal Markets

Chapter 1 - The Structure of a Behavioral Revolution

 1.1 - Abnormal markets, irrational investors

 1.2 - Anomalies, fast and slow

 1.3 - Sell in May and go away?

1.4 - Law on the market

1.5 - Raw emotion

1.6 - Trade like a girl

Chapter 2 - Mental Accounting, Emotional Hierarchies, and Behavioral Heuristics

 2.1 - Keeping emotional score

 2.2 - Maslowian portfolio theory

 2.3 - "Shots at greatness": Rehabilitating self-actualization in neo-Maslowian thought as a trading strategy

 2.4 - Behavioral environmental economics

 2.5 - Fables of the reconstruction

 

Chapter 3 - Higher-Moment Capital Asset Pricing and Its Behavioral Implications

 3.1 - The conventional capital asset pricing model

 3.2 - Four-moment CAPM as a Taylor series expansion

 3.3 - A bridge between econometric and behavioral views of low volatility

 

Chapter 4 - Tracking the Low-Volatility Anomaly Across Behavioral Space

 4.1 - The low-volatility anomaly and Bowman's paradox

 4.2 - Beta as a composite measure of volatility and correlation

 4.3 - Downside volatility and correlation tightening in emerging markets

 4.4 - Pricing and predicting correlation risk

 4.5 - Evidence against a correlation risk premium

 

Chapter 5 - The Intertemporal Capital Asset Pricing Model: Hedging Investment Risk Across Time

 5.1 - The intertemporal capital asset pricing model

 5.2 - Bad beta, good beta

 5.3 - Addressing the low-volatility anomaly through spatial and temporal bifurcations of beta

 

Chapter 6 - Risk Aversion

 6.1 - The Arrow-Pratt measures of risk aversion; the coefficient of absolute risk aversion

 6.2 - The coefficient of relative risk aversion

 6.3 - Pratt's risk-averse insurance premium

 6.4 - Hyperbolic absolute risk aversion

 6.5 - A comparison with scale-invariant models of financial returns

 6.6 - Risk aversion, risk tolerance, and their relationship to the Sharpe and kappa ratios

 6.7 - The Allais paradox

 6.8 - The St. Petersburg paradox

 

Chapter 7 - The Equity Risk Premium and the Equity Premium Puzzle

7.1 - The equity risk premium

 7.2 - A cautious stroll off Wall Street

 7.3 - The equity premium puzzle

 7.4 - Another puzzle, and a challenge

 7.5 - Habit formation and the life-cycle hypothesis

 7.6 - Catching up with the Joneses

 7.7 - Macroeconomic disaster and personal peril

 7.8 - Familiarity breeds irrationality

 7.9 - Gaudeamus igitur: The familiar but curious economics of university endowments

 

Chapter 8 - Prospect Theory

 8.1 - Comprehensive accounts of behavioral finance

 8.2 - Responding to anomalies in expected utility theory

 8.3 - The value function

 8.4 - Flagging prospect theory: Log-logistic distribution

 8.5 - Flagging prospect theory: Two-parameter lognormal distribution

 8.6 - Cumulative prospect theory

 8.7 - The weighting function

 8.8 - The fourfold pattern

 

Chapter 9 - Specific Applications of Prospect Theory to Behavioral Finance

 9.1 - The longing for lotteries

 9.2 - Initial public offerings

9.3 - Prospect theory and Bowman's paradox

 9.4 - Prospect theory and the equity premium puzzle: Myopic loss aversion

 9.5 - Another equity premium solution: Prospect theory and asset pricing

 

Chapter 10 - Beyond Hope and Fear: Behavioral Portfolio Theory

 10.1 - Prospect's progress: Beyond theories of Everyman

 10.2 - SP/A theory

 10.3 - The human heart in conflict with itself

 10.4 - Roy's safety-first criterion

 10.5 - Behavioral portfolio theory

 10.6 - The practical consequences of behaviorally sensitive portfolio optimization

 10.7 - Behavioral portfolio theory as a form of value-at-risk (VaR) analysis

 

Chapter 11 - Behavioral Gaps Between Hypothetical Investment Returns and Actual Investor Returns

 11.1 - Hypothetical investment returns versus actual investor returns

 11.2 - The disposition effect

 11.3 - The behavioral origins of the investment gap

 11.4 - : Measuring behavioral gaps in investment performance

 11.5 - The effect of capital gains taxation

 

Chapter 12 - Irrational Exuberance: Momentum Crashes and Speculative Bubbles

 12.1 - Some speculation about speculative bubbles

 12.2 - The behavioral origins of stock market momentum

 12.3 - Momentum crashes

 12.4 - Liquidity risk

 12.5 - A simple model of informed and naive trading

 

Conclusion: The Monster and the Sleeping Queen