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Advances in Behavioral Finance Volume II The Roundtable Series in Behavioral Economics The Roundtable Series in Behavioral Economics aims to advance research in the new interdisciplinary ?eld of behavioral economics. Behavioral economics uses facts, models, and methods from neighboring sciences to establish descriptively ac- curate ?ndings about human cognitive ability and social interaction and to explore the implications of these ?ndings for economic behavior. The most fertile neighbor- ing science in recent decades has been psychology, but sociology, anthropology, biology, and other ?elds can usefully in?uence economics as well. The Roundtable Series publishes books in economics that are deeply rooted in empirical ?ndings or methods from one or more neighboring sciences and advance economics on its own terms—generating theoretical insights, making more accurate predictions of ?eld phenomena, and suggesting better policy. Colin Camerer and Ernst Fehr, editors Other Volumes in the Series Behavioral Game Theory: Experiments in Strategic Interactionby Colin F. Camerer Microeconomics: Behavior, Institutions, and Evolutionby Samuel Bowles Advances in Behavioral Economics, edited by Colin F. Camerer, George Loewen- stein, and Matthew Rabin Advances in Behavioral Finance: Volume II, edited by Richard H. Thaler The Behavioral Economics Roundtable Henry Aaron George Loewenstein George Akerlof Sendhil Mullainathan Linda Babcock Matthew Rabin Colin Camerer Thomas Schelling Peter Diamond Eldar Sha?r Jon Elster Robert Shiller Ernst Fehr Cass Sunstein Daniel Kahneman Richard Thaler David Laibson Richard Zeckhauser Advances in Behavioral Finance Vo l u m e I I Edited by Richard H. Thaler russell sage foundation new york princeton university press princeton and oxford Copyright © 2005 by Russell Sage Foundation Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press, 3 Market Place, Woodstock, Oxfordshire OX20 1SY and Russell Sage Foundation 112 East 64th Street, New York, New York 10021 All Rights Reserved Library of Congress Control Number 93012149 British Library Cataloging-in-Publication Data is available This book has been composed in Sabon Printed on acid-free paper. ? pup.princeton.edu www.russellsage.org Printed in the United States of America 1 3 5 7 9 10 8 6 4 2 This book is dedicated to the memory of Fischer Black (1938–1995) and Amos Tversky (1937–1996). CONTENTS Preface xi Richard H. Thaler Acknowledgments xix List of Abbreviations xxiii Chapter1 A Survey of Behavioral Finance 1 Nicholas Barberis and Richard H. Thaler Part I Limits to Arbitrage Chapter2 The Limits of Arbitrage 79 Andrei Shleifer and Robert W. Vishny Chapter3 How Are Stock Prices Affected by the Location of Trade? 102 Kenneth A. Froot and Emil M. Dabora Chapter4 Can the Market Add and Subtract? Mispricing in Tech Stock Carve-outs 130 Owen A. Lamont and Richard H. Thaler Part II Stock Returns and the Equity Premium Chapter5 Valuation Ratios and the Long-run Stock Market Outlook: An Update 173 John Y. Campbell and Robert J. Shiller Chapter6 Myopic Loss Aversion and the Equity Premium Puzzle 202 Shlomo Benartzi and Richard H. Thaler Chapter7 Prospect Theory and Asset Prices 224 Nicholas Barberis, Ming Huang, and Tano Santos viii CONTENTS Part III Empirical Studies of Overreaction and Underreaction Chapter8 Contrarian Investment, Extrapolation, and Risk 273 Josef Lakonishok, Andrei Shleifer, and Robert W. Vishny Chapter9 Evidence on the Characteristics of Cross-sectional Variation in Stock Returns 317 Kent Daniel and Sheridan Titman Chapter10 Momentum 353 Narasimhan Jegadeesh and Sheridan Titman Chapter11 Market Ef?ciency and Biases in Brokerage Recommendations 389 Roni Michaely and Kent L. Womack Part IV Theories of Overreaction and Underreaction Chapter12 A Model of Investor Sentiment 423 Nicholas Barberis, Andrei Shleifer, and Robert W. Vishny Chapter13 Investor Psychology and Security Market Under- and Overreaction 460 Kent Daniel, David Hirshleifer, and Avanidhar Subrahmanyam Chapter14 A Uni?ed Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets 502 Harrison Hong and Jeremy C. Stein Part V Investor Behavior Chapter15 Individual Investors 543 Brad M. Barber and Terrance Odean Chapter16 Naive Diversi?cation Strategies in De?ned Contribution Savings Plans 570 Shlomo Benartzi and Richard H. Thaler Part VI Corporate Finance Chapter17 Rational Capital Budgeting in an Irrational World 605 Jeremy C. Stein CONTENTS ix Chapter18 Earnings Management to Exceed Thresholds 633 François Degeorge, Jayendu Patel, and Richard Zeckhauser Chapter19 Managerial Optimism and Corporate Finance 667 J. B. Heaton List of Contributors 685 Index 695
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