SLOAN SCHOOL OF MANAGEMENT MASSACHUSETTS INSTITUTE OF TECHNOLOGY Jonathan Lewellen E52-436 258-8408; [email protected]

Advanced Financial Economics III 15.442J Fall 2003 SYLLABUS

This course studies the empirical asset-pricing literature and the econometric methods used in empirical research. We will discuss many topics in asset pricing, including market efficiency, the predictability of stock and bond returns, excess volatility and present value relations, the static and consumption CAPMs, multifactor asset-pricing models, event studies, and Bayesian methods. Students are expected to participate actively in class discussions. READING

The readings consist almost entirely of journal articles, which I will distribute in class. A few readings come from the following books. Fama’s book is no longer in print, but I recommend the other books to supplement the journal articles. • Fama, Eugene, 1976. Foundations of Finance. Basic Books, New York, NY. ‘Fama’ in the outline below. • Campbell, John, Andrew Lo, and A. Craig MacKinlay, 1997. The Econometrics of Financial Markets. Princeton University Press, Princeton, NJ. ‘CLM’ in the outline. • Cochrane, John, 2001. Asset Pricing. Princeton University Press, Princeton, NJ. ‘Cochrane’ in the outline. WEB PAGE

Course material will be posted under ‘Teaching’ on my web page http://web.mit.edu/lewellen/www/. I also have links to various data sites, including the St. Louis Fed (a good source for macroeconomic data), Dow Jones and Morgan Stanley (stock indices), and the web pages of Ken French (portfolio and factor returns), Jay Ritter (IPO data), and Robert Shiller (S&P returns, dividends, and earnings stretching back to 1870). COURSE REQUIREMENTS AND GRADING

Readings are the most important component of the course. Students are expected to study the articles before class and come prepared to discuss the methodology and main findings of each paper. Class participation will be weighted heavily in the final grades. There will also be periodic assignments. These will consist of both problem sets and data analysis, in which I will ask you to replicate or extend results in the literature. I expect the assignments to take less than one day per week. The course will also have a final during the normal MIT finals week. This exam should be straightforward if you attend class and study the assigned articles each week.

OUTLINE 1. MARKET EFFICIENCY 2. THE TIME-SERIES PROPERTIES OF RETURNS

a. First tests of predictability b. Statistical issues c. Recent evidence on predictability d. Predictability, excess volatility, and present value relations e. Interest rates and inflation f. Time-varying volatility and expected returns g. Consumption and the equity premium h. Short-horizon lead-lag relations in returns 3. THE CROSS SECTION OF EXPECTED RETURNS

a. The CAPM b. Tests of portfolio efficiency c. Empirical evidence – size, B/M, momentum, and reversals d. Multifactor models and mean-variance efficiency e. Multifactor models – empirical tests f. The consumption CAPM g. Performance evaluation and mutual funds h. Conditional asset pricing tests 4. MISCELLANEOUS TOPICS

a. Event studies b. Mutual funds c. Bayesian investors and Bayesian methods d. Investor sentiment and closed-end funds e. Home bias in portfolio choice f. Index addition g. Pricing and the location of trade h. Rational bubbles

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READING LIST Carefully read articles marked *; skim articles marked **. 1. MARKET EFFICIENCY * Fama, Chapter 5. * Fama, Eugene, 1975, Short-term interest rates as predictors of inflation, American Economic Review 65, 269-282. * Summers, Lawrence, 1986, Does the stock market rationally reflect fundamental values, Journal of Finance 41, 591-601. Muth, John, 1961, Rational expectations and the theory of price movements, Econometrica 29, 1-23. Samuelson, Paul, 1965, Proof that properly anticipated prices fluctuate randomly, Industrial Management Review (Spring), 41-49. Lucas, Robert, 1978, Asset prices in an exchange economy, Econometrica 46, 1429-1446. 2. THE TIME-SERIES PROPERTIES OF RETURNS 2.1. First tests of predictability * Fama, Eugene and G. William Schwert, 1977, Asset returns and inflation, Journal of Financial Economics 5, 115-146. * Fama, Eugene and Kenneth French, 1988, Permanent and temporary components of stock prices, Journal of Political Economy 96, 246-273. * Fama, Eugene and Kenneth French, 1988, Dividends yields and expected stock returns, Journal of Financial Economics 22, 3-25. ** Fama, Eugene and Kenneth French, 1989, Business conditions and expected returns on stocks and bonds, Journal of Financial Economics 25, 23-49. CLM, Chapter 2. Keim, Donald and Robert Stambaugh, 1986, Predicting returns in the stock and bond markets, Journal of Financial Economics 17, 357-390. Campbell, John, 1987, Stock returns and the term structure, Journal of Financial Economics 18, 373-399. Poterba, James and Lawrence Summers, 1988, Mean reversion in stock prices: Evidence and implications, Journal of Financial Economics 22, 27-59. Campbell, John and Robert Shiller, 1988, The dividend-price ratio and expectations of future dividends and discount factors, Review of Financial Studies 1, 195-228.

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2.2. Statistical issues Stambaugh, Robert, 1999, Predictive regressions, Journal of Financial Economics 54, 375-421. Mankiw, N. Gregory and Matthew Shapiro, 1986, Do we reject too often? Small sample properties of tests of rational expectations models, Economics Letters 20, 139-145. Maddala, G. S. and H. Li, 1996. Bootstrap based tests of financial models. Handbook of Statistics, Vol. 14. Horowitz, Joel, 2000. The bootstrap. Handbook of Econometrics, Vol. 5. Kendall, Maurice, 1954, Note on bias in the estimation of autocorrelation, Biometrika 41, 403-404. Marriott, F.H.C. and J.A. Pope, 1954, Bias in the estimation of autocorrelations, Biometrika 41, 390-402. 2.3. Financial ratios: More recent evidence * Lewellen, Jonathan, 2003. Predicting returns with financial ratios. Forthcoming in Journal of Financial Economics. Kothari, S.P. and Jay Shanken, 1997, Book-to-market, dividend yield, and expected market returns: A time-series analysis, Journal of Financial Economics 44, 169-203. Campbell, John and Motohiro Yogo, 2003. Efficient tests of stock return predictability. Working paper (Harvard University, Cambridge, MA). Hodrick, Robert, 1992, Dividend yields and expected stock returns: Alternative procedures for inference and measurement, Review of Financial Studies 5, 357-386. Goetzmann, William and Philippe Jorion, 1993, Testing the predictive power of dividend yields, Journal of Finance 48, 663-679. Nelson, Charles and Myung Kim, 1993, Predictable stock returns: The role of small sample bias, Journal of Finance 48, 641-661. Cutler, David, James Poterba, and Lawrence Summers, 1991, Speculative dynamics, Review of Economic Studies 58, 529-546. Goyal, Amit and Ivo Welch, 1999, Predicting the equity premium, Working paper (Yale School of Management, New Haven, CT). Lee, Charles, James Myers, and Bhaskaran Swaminathan, 1999, What is the instrinsic value of the Dow?, Journal of Finance 54, 1693-1741. Baker, Malcolm and Jeffrey Wurgler, 2000. The equity share in new issues and aggregate stock returns. Journal of Finance 55, 2219-2257. 2.4. Mean reversion: More recent evidence * Lewellen, Jonathan, 2002. Temporary movements in stock prices. Working paper (MIT, Cambridge, MA). ** Richardson, Matthew, 1993. Temporary components of stock prices: A skeptic’s view. Journal of Business 4

and Economic Statistics 11, 199-207. Kim, Myung, Charles Nelson, and Richard Startz, 1991. Mean reversion in stock prices? A reappraisal of the the empirical evidence. Review of Economic Studies 58, 515-528. Jegadeesh, Narasimhan, 1990. Seasonality in stock price mean reversion: Evidence from the U.S. and the U.K. Journal of Finance 46, 1427 – 1444. Richardson, Matthew and James Stock, 1989, Drawing inferences from statistics based on multiyear asset returns, Journal of Financial Economics 25, 323-348. Richardson, Matthew and Tom Smith, 1994. A unified approach to testing for serial correlation in stock returns. Journal of Business 67, 371-399. 2.5. Predictability, excess volatility, and present value relations * Campbell, John and Robert Shiller, 1988, The dividend-price ratio and expectations of future dividends and discount factors, Review of Financial Studies 1, 195-228. * Campbell, John, 1991, A variance decomposition for stock returns, Economic Journal 101, 157-179. Kothari, S.P., J. Lewellen, and J. Warner, 2003. Stock returns, aggregate earnings surprises, and behavioral finance. Working paper (MIT, Cambridge, MA). LeRoy, Stephen, 1996. Stock price volatility. Handbook of Statistics, Vol. 14. Shiller, Robert, 1981, Do stock prices move too much to be justified by subsequent changes in dividends?, American Economic Review 7, 421-436. LeRoy, Stephen and Richard Porter, 1981, The present value relation: Tests based on implied variance bounds, Econometrica 49, 555-574. Fama, Eugene, 1990, Stock returns, expected returns, and real activity, Journal of Finance 45, 1089-1108. Kothari, S.P. and Jay Shanken, 1992, Stock return variation and expected dividends: A time-series and cross-sectional analysis, Journal of Financial Economics 31, 177-210. Vuolteenaho, Tuomo, 2000, Understanding the aggregate book-to-market ratio, Working paper (Harvard University, Cambridge, MA). Barsky, Robert and J. Bradford DeLong, 1993, Why does the stock market fluctuate?, Quarterly Journal of Economics 108, 291-311. Kleidon, Allan, 1986, Anomalies in financial economics: Blueprint for change?, Journal of Business 59, 469-495. Marsh, Terry and Robert Merton, 1986, Dividend variability and variance bound tests for the rationality of stock market prices, American Economic Review 76, 483-498. Campbell, John and Robert Shiller, 1988, Stock prices, earnings, and expected dividends, Journal of Finance 43, 661-676.

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Mankiw, N. Gregory, David Romer, and Matthew Shapiro, 1991, Stock market forecastibility and volatility: A statistical appraisal, Review of Economic Studies 58, 455-477. 2.6. Consumption and the equity premium * Cochrane, Chapters 1, 2, and 21. * Lettau, Martin and Sydney Ludvigson, 2001, Consumption, aggregate wealth, and expected stock returns, Journal of Finance 56, 815-849. * Fama, Eugene and Kenneth French, 2002, The equity premium, Journal of Finance 57, 637-359. CLM, Chapter 8. Campbell, John, 2002. Asset pricing at the millenium. Journal of Finance 55, 1515-1657. Hansen, Lars P. and Kenneth Singleton, 1982, Generalized instrumental variables estimation of nonlinear rational expectations models, Econometrica 50, 1269-1286. Mehra, Rajnish and Edward Prescott, 1985, The equity premium: A puzzle, Journal of Monetary Economics 15, 145-161. Epstein, Larry and Stanley Zin, 1991. Substitution, risk aversion, and the temporal behavior of consumption and asset returns: An empirical analysis. Journal of Political Economy 99, 263-286. Campbell, John and John Cochrane, 1999. By force of habit: A consumption-based explanation of aggregate stock market behavior. Journal of Political Economy 107, 205-251. Kocherlakota, Narayana, 1996, The equity premium: It’s still a puzzle, Journal of Economic Literature 34, 42-71. Campbell, John, 1993. Intertemporal asset pricing without consumption data. American Economic Review 83, 487-512. 2.7. Interest rates * Fama, Eugene, 1990, Term structure forecasts of interest rates, inflation, and real returns, Journal of Monetary Economics 25, 59-76. * Campbell, John and Robert Shiller, 1991, Yield spreads and interest rate movements: A bird’s eye view, Review of Economic Studies 58, 495-514. * Cochrane, John and Monika Piazzesi, 2002. Bond risk premia, Working paper (University of Chicago, Chicago, IL). CLM, Chapter 10 and 11. Fama, Eugene, 1984, The information in the term structure, Journal of Financial Economics 13, 509-528. Fama, Eugene, 1984, Term premiums in bond returns, Journal of Financial Economics 13, 529-546. Bekaert, Geert, Robert Hodrick, and David Marshall, 1997, On biases in tests of the expectations 6

hypothesis of the term structure of interest rates, Journal of Financial Economics 44, 309-348. Dai, Qiang and Kenneth Singleton, 2000, Specification analysis of affine term structure models, Journal of Finance 55, 1943-1978. Gibbon, Michael and Krishna Ramaswamy, 1993, A test of the Cox, Ingersoll, and Ross model of the term structure, Review of Financial Studies 6, 619-658. Brown, Stephen and Philip Dybvig, 1986, The empirical implications of the CIR theory of the term structure of interest rates, Journal of Finance 41, 617-630. 2.8. Time-varying volatility * French, Kenneth, G. William Schwert, and Robert Stambaugh, 1987, Expected stock returns and volatility, Journal of Financial Economics 19, 3-29. ** Campbell, John and Ludger Hentschel, 1992, No news is good news: An asymmetric model of changing volatility in stock returns, Journal of Financial Economics 31, 281-318. Lettau, Martin and Sydney Ludvigson, 2003. Measuring and modeling variation in the risk-return tradeoff. Working paper (New York University, NY). Engle, Robert, 1982, Autoregressive conditional heteroskedasticity with estimates of the variance of United Kingdom inflation, Econometrica 50, 987-1007. Bollerslev, Tim, 1986, Generalized autoregressive conditional heteroskedasticity, Journal of Econometrics 31, 307-328. Schwert, G. William, 1989, Why does stock market volatility change over time?, Journal of Finance 44, 1115-1153. Pagan, Adrian and G. William Schwert, 1990, Alternative models for conditional stock volatility, Journal of Econometrics 45, 267-290. Hentschel, Ludger, 1995, All in the family: Nesting symmetric and asymmetric GARCH models, Journal of Financial Economics 39, 71-104. 2.9. Short-horizon lead-lag relations in stock returns * Lo, Andrew and A. Craig MacKinlay, 1990, When are contrarian profits due to stock market overreaction?, Review of Financial Studies 3, 175-205. ** Jegadeesh, Narasimhan and Sheridan Titman, 1995. Overreaction, delayed reaction, and contrarian profits. Review of Financial Studies 8, 973-993. Boudoukh, Jacob, Matthew Richardson, and Robert Whitelaw, 1994, A tale of three schools: Insights on autocorrelations of short-horizon stock returns, Review of Financial Studies 7, 539-573. Lehmann, Bruce, 1990, Fads, martingales, and market efficiency, Quarterly Journal of Economics 105, 128. Lo, Andrew and A. Craig MacKinlay, 1988, Stock market prices do not follow random walks: Evidence 7

from a simple specification test, Review of Financial Studies 1, 41-66. 2.10. Miscellaneous French, Kenneth and Richard Roll, 1986, Stock return variances: The arrival of information and the reaction of traders, Journal of Financial Economics 17, 5-26. Roll, Richard, 1984, Orange juice and weather, American Economic Review 74, 861-880. Roll, Richard, 1988, R2, Journal of Finance 43, 541-566. Cutler, David, James Poterba, and Lawrence Summers, 1989, What moves stock prices?, Journal of Portfolio Management 15, 4-12. Brown, Stephen, William Goetzmann, and Stephen Ross, 1995, Survival, Journal of Finance 50, 853-873. 3. THE CROSS SECTION OF EXPECTED RETURNS 3.1. The CAPM * Fama, Chapters 7 and 8. Cochrane, Chapters 5, 6, and 7 Sharpe, William F., 1964, Capital asset prices: A theory of market equilibrium under conditions of risk, Journal of Finance 19, 425-442. Lintner, John, 1965, The valuation of risky assets and the selection of risky investments in stock portfolios and capital budgets, Review of Economics and Statistics 47, 13-37. Black, Fischer, 1972, Capital market equilibrium with restricted borrowing, Journal of Business 45, 444455. 3.2. Tests of portfolio efficiency * Fama, Chapter 9. * Gibbons, Michael, Stephen Ross, and Jay Shanken, 1989, A test of the efficiency of a given portfolio, Econometrica 57, 1121-1152. CLM, Chapter 5 and Cochrane, Chapter 12. Shanken, Jay, 1995. Statistical methods in tests of portfolio efficiency: A synthesis. In: G.S. Maddala and C.R. Rao, eds., Handbook of Statistics, Vol. 14 (North Holland, Amsterdam). Early tests: Black, Fischer, Michael Jensen, and Myron Scholes, 1972, The capital asset pricing model: Some empirical tests, in: M. Jensen, ed., Studies in the theory of capital markets (Praeger, NY), 79-121.

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Fama, Eugene and James MacBeth, 1973, Risk, return and equilibrium: Empirical tests, Journal of Political Economy 81, 607-636. Perspective: Roll, Richard, 1977, A critique of the asset pricing theory’s tests – Part 1: On past and potential testability of the theory, Journal of Financial Economics 4, 129-176. Roll, Richard, 1978, Ambiguity when performance is measured by the securities market line, Journal of Finance 33, 1051-1069. Roll, Richard and Stephen Ross, 1994, On the cross-sectional relation between expected returns and betas, Journal of Finance 49, 101-121. Kandel, Shmuel and Robert Stambaugh, 1995, Portfolio inefficiency and the cross-section of expected returns, Journal of Finance 50, 157-184. More multivariate tests: Jobson, J.D. and Bob Korkie, 1982, Potential performance and tests of portfolio efficiency, Journal of Financial Economics 10, 433-466. Gibbons, Michael, 1982, Multivariate tests of financial models: A new approach, Journal of Financial Economics 10, 3-27. Kandel, Shmuel, 1984, The likelihood ratio test statistics of mean-variance efficiency without a riskless asset, Journal of Financial Economics 13, 575-592. Shanken, Jay, 1985, Multivariate tests of the zero-beta CAPM, Journal of Financial Economics 14, 327348. MacKinlay, A. Craig, 1987, On multivariate tests of the CAPM, Journal of Financial Economics 18, 341371. Kandel, Shmuel and Robert Stambaugh, 1989, A mean-variance framework for tests of asset pricing models, Review of Financial Studies 2, 125-156. Statistics of two-pass regressions: Shanken, Jay, 1992, On the estimation of beta-pricing models, Review of Financial Studies 5, 1-33. Bayesian tests: Shanken, Jay, 1987, A Bayesian approach to testing portfolio efficiency, Journal of Financial Economics 19, 195-216. McCulloch, Robert and Peter Rossi, 1990, Posterior, predictive, and utility-based approaches to testing the arbitrage pricing theory, Journal of Financial Economics 28, 7-38. Harvey, Campbell and Goufu Zhou, 1990, Bayesian inference in asset pricing tests, Journal of Financial Economics 26, 221-254.

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Kandel, Shmuel, Robert McCulloch, and Robert Stambaugh, 1995, Bayesian inference and portfolio efficiency, Review of Financial Studies 8, 1-53. GMM and nonnormalities: Affleck-Graves, John, and Bill McDonald, 1989, Nonnormalities and tests of asset pricing theories, Journal of Finance 44, 889-908. MacKinlay, A. Craig and Matthew Richardson, 1991, Using generalized method of moments to test meanvariance efficiency, Journal of Finance 46, 511-527. Zhou, Goufu, 1991, Small sample tests of portfolio efficiency, Journal of Financial Economics 30, 165191. Zhou, Goufu, 1993, Asset-pricing tests under alternative distributions, Journal of Finance 48, 1927-1942. 3.3. Empirical tests: Size and B/M part I * Fama, Eugene and Kenneth French, 1992, The cross-section of expected stock returns, Journal of Finance 47, 427-465. ** Lakonishok, Josef, Andrei Shleifer, and Robert Vishny, 1994, Contrarian investment, extrapolation, and risk, Journal of Finance 49, 1541-1578. ** Cohen, Randolph, Christopher Polk, and Tuomo Vuolteenaho, 2002. Does risk or mispricing explain the cross-section of stock prices?, Working paper (Harvard University, Cambridge, MA). La Porta, Rafael, Josef Lakonishok, Andrei Shleifer, and Robert Vishny, 1997, Good news for value stocks: Further evidence on market efficiency, Journal of Finance 52, 859-874. Ball, Ray, 1978, Anomalies in relationships between securities’ yields and yield-surrogates, Journal of Financial Economics 6, 103-126. Berk, Jonathan, 1995, A critique of size-related anomalies, Review of Financial Studies 8, 275-286. Fama, Eugene and Kenneth French, 1995, Size and book-to-market factors in earnings and returns, Journal of Finance 50, 131-155. Kothari, S.P., Jay Shanken, and Richard Sloan, 1995, Another look at the cross-section of expected stock returns, Journal of Finance 50, 185-224. Dechow, Patricia and Richard Sloan, 1997, Returns to contrarian investment strategies: Tests of naïve expectations hypotheses, Journal of Financial Economics 43, 3-27. Handa, Puneet, S.P. Kothari, and Charles Wasley, 1989, The relation between the return interval and betas: Implications for the size effect, Journal of Financial Economics 23, 79-100. 3.4. Empirical tests: Momentum and contrarian profits * DeBondt, Werner and Richard Thaler, 1985, Does the stock market overreact?, Journal of Finance 40, 793-808.

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* Jegadeesh, Narasimhan and Sheridan Titman, 1993, Returns to buying winners and selling losers: Implications for stock market efficiency, Journal of Finance 48, 65-91. More contrarian: DeBondt, Werner and Richard Thaler, 1987, Further evidence on investor overreaction and stock market seasonality, Journal of Finance 42, 557-581. Chan, K.C., 1988, On the contrarian investment strategy, Journal of Business 61, 147-163. Conrad, Jennifer and Gautam Kaul, 1993, Long-term market overreaction or biases in computed returns?, Journal of Finance 48, 39-63. Ball, Ray and S.P. Kothari, 1989, Nonstationary expected returns: Implications for tests of market efficiency and serial correlation in returns, Journal of Financial Economics 25, 51-74. Chopra, Navin, Josef Lakonishok, and Jay Ritter, 1992, Measuring abnormal performance: Do stocks overreact?, Journal of Financial Economics 31, 235-268. Ball, Ray, S.P. Kothari, and Jay Shanken, 1995, Problems in measuring portfolio performance: An application to contrarian investment strategies, Journal of Financial Economics 38, 79-107. More momentum: Bernard, Victor and Jacob Thomas, 1990, Evidence that stock prices do not fully reflect the implications of current earnings for future earnings, Journal of Accounting and Economics 13, 305-340. Chan, Louis, Narasimhan Jegadeesh, and Josef Lakonishok, 1996, Momentum strategies, Journal of Finance 51, 1681-1713. Moskowitz, Tobias and Mark Grinblatt, 1999. Do industries explain momentum?. Journal of Finance 54, 1249-1290. Lewellen, Jonathan, 2002. Momentum and autocorrelation in stock returns. Review of Financial Studies 15, 533-563. Grundy, Bruce and J. Spencer Martin, 1998, Understanding the nature of the risks and the source of the rewards to momentum investing, Working paper (University of Pennsylvania, Philadelphia, PA). Hong, Harrison, Terrence Lim, and Jeremy Stein, 2000, Bad news travels slowly: Size, analyst coverage, and the profitability of momentum strategies, Journal of Finance 55, 265-295. 3.5. Empirical tests: Miscellaneous Loughran, Tim and Jay Ritter, 1995. The new issues puzzle. Journal of Finance 50, 23-51. Sloan, Richard, 1996. Do stock prices fully reflect information in accruals and cashflows for future earnings? The Accounting Review 71, 289-315. Ikenberry, D., J. Lakonishok, and T. Vermaelen, 1995. Market underreaction to open market share repurchases. Journal of Financial Economics 39, 181-208.

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Amihud, Yakov and Haim Mendelson, 1986, Asset pricing and the bid-ask spread, Journal of Financial Economics 15, 223-249. Haugen, Robert and Nardin Baker, 1996, Commonality in the determinants of expected stock returns, Journal of Financial Economics 41, 401-440. Reinganum, Marc, 1990, Market microstructure and asset pricing: An empirical investigation of NYSE and NASDAQ securities, Journal of Financial Economics 28, 127-148. 3.6. Multifactor asset pricing models Merton, Robert, 1973, An intertemporal asset pricing model, Econometrica 41, 867-887. Ross, Stephen, 1976, The arbitrary pricing theory of capital asset pricing, Journal of Economic Theory 13, 341-360. Is the APT testable?: Shanken, Jay, 1982, The arbitrage pricing theory: Is it testable?, Journal of Finance 37, 1129-1140. Dybvig, Philip and Stephen Ross, 1985, Yes, the APT is testable, Journal of Finance 40, 1173-1188. Shanken, Jay, 1985, Multi-beta CAPM or equilibrium-APT?: A reply, Journal of Finance 40, 1189-1196. Shanken, Jay, 1992, The current state of the Arbitrage Pricing Theory, Journal of Finance 47, 1569-1574. 3.7. Multifactor models and mean-variance efficiency * Shanken, Jay, 1987, Multivariate proxies and asset pricing relations: Living with the Roll critique, Journal of Financial Economics 18, 91-110. * Fama, Eugene, 1996, Multifactor portfolio efficiency and multifactor asset pricing, Journal of Financial and Quantitative Analysis 31, 441-465. CLM, Chapter 6. Chamberlain, Gary and Michael Rothschild, 1983, Arbitrage, factor structure, and mean-variance analysis on large asset markets, Econometrica 51, 1281-1304. Huberman, Gur, Shmuel Kandel, and Robert Stambaugh, 1987, Mimicking portfolios and exact arbitrage pricing, Journal of Finance 42, 1-9. Huberman, Gur and Shmuel Kandel, 1987, Mean-variance spanning, Journal of Finance 42, 873-888. Grinblatt, Mark and Sheridan Titman, 1987, The relation between mean-variance efficiency and arbitrage pricing, Journal of Business 60, 97-112. 3.8. Empirical tests of multifactor models (Size and B/M part II) * Fama, Eugene and Kenneth French, 1993, Common risk factors in the returns on stocks and bonds, Journal of Financial Economics 33, 3-56. 12

* MacKinlay, A. Craig, 1995, Multifactor models do not explain deviations from the CAPM, Journal of Financial Economics 38, 3-28. Daniel, Kent and Sheridan Titman, 1997, Evidence on the characteristics of cross-sectional variation in stock returns, Journal of Finance 52, 1-33. Chen, Nai-Fu, Richard Roll, and Stephen Ross, 1986, Economic forces and the stock market, Journal of Business 59, 383-403. Fama, Eugene and Kenneth French, 1996, Multifactor explanations of asset pricing anomalies, Journal of Finance 51, 55-84. Davis, James, Eugene Fama, and Kenneth French, 2000, Characteristics, covariances, and average returns: 1929 – 1997, Journal of Finance 55, 389-406. Connor, Gregory and Robert Korajczyk, 1986, Performance measurement with the arbitrary pricing theory: A new framework for analysis, Journal of Financial Economics 15, 373-394. Connor, Gregory and Robert Korajczyk, 1988, Risk and return in an equilibrium APT: Application of a new test methodology, Journal of Financial Economics 21, 255-289. Brennan, Michael, Tarun Chordia, and Avanidhar Subrahmanyam, 1998, Alternative factor specifications, security characteristics, and the cross-section of expected stock returns, Journal of Financial Economics 49, 345-373. Roll, Richard and Stephen Ross, 1980, An empirical investigation of the Arbitrage Pricing Theory, Journal of Finance 35, 1073-1103. Lehmann, Bruce and David Modest, 1988, The empirical foundations of the Arbitrage Pricing Theory, Journal of Financial Economics 21, 213-254. 3.9. Consumption CAPM and pricing kernels * Hansen, Lars P. and Ravi Jagannathan, 1991, Implications of security market data for models of dynamic economies, Journal of Political Economy 99, 225-262. * Campbell, John, 1996, Understanding risk and return, Journal of Political Economy 104, 298-345. CLM, Chapter 8 and Cochrane, Chapters 10, 11, 13, 15, 16 Breeden, Douglas, 1979, An intertemporal asset pricing model with stochastic consumption and investment opportunities, Journal of Financial Economics 7, 265-296. Hansen, Lars P. and Ravi Jagannathan, 1997. Assessing specification errors in stochastic discount factor models. Journal of Finance 52, 557-590. Breeden, Douglas, Michael Gibbons, and Robert Litzenberger, 1989. Empirical tests of the consumption CAPM. Journal of Finance 44, 231-262. Campbell, John and John Cochrane, 2000, Explaining the poor performance of consumption-based asset pricing models, Journal of Finance 55, 2863-2878.

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3.10. Conditional asset pricing tests * Lettau, Martin and Sydney Ludvigson, 2001, Resurrecting the (C)CAPM: A cross-sectional test when risk premia are time varying, Journal of Political Economy 109, 1238 – 1287. * Lewellen, Jonathan and Stefan Nagel, 2003. The conditional CAPM does not explain asset-pricing anomalies. Working paper (MIT, Cambridge, MA). ** Shanken, Jay, 1990, Intertemporal asset pricing: An empirical investigation, Journal of Econometrics 45, 99-120. Jagannathan, Ravi and Zhenyu Wang, 1996. The conditional CAPM and the cross-section of stock returns. Journal of Finance 51, 3-53. Cochrane, Chapter 8. Lewellen, Jonathan, 1999, The time-series relations among expected return, risk, and book-to-market, Journal of Financial Economics 54, 5-43. Harvey, Campbell, 1989, Time-varying conditional covariances in tests of asset pricing models, Journal of Financial Economics 24, 289-317. Ferson, Wayne and Campbell Harvey, 1991, The variation of economic risk premiums, Journal of Political Economy 99, 385-415. 3.12. Miscellaneous Scholes, Myron and Joseph Williams, 1977, Estimating betas with nonsynchronous data, Journal of Financial Economics 5, 309-327. Dimson, Elroy, 1979, Risk measurement when shares are subject to infrequent trading, Journal of Financial Economics 7, 197-226. Blume, Marshall and Robert Stambaugh, 1983, Biases in computed returns: An application to the size effect, Journal of Financial Economics 12, 387-404. Roll, Richard, 1983, On computing mean returns and the small firm premium, Journal of Financial Economics 12, 371-386. 4. MISCELLANEOUS 4.1. Event studies * Fama, Eugene, 1998, Market efficiency, long-term returns, and behavioral finance, Journal of Financial Economics 49, 283-306. * Loughran, Tim and Jay Ritter, 2000, Uniformly least powerful tests of market efficiency, Journal of Financial Economics 55, 361-389. CLM, Chapter 4.

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Barber, Brad and John Lyon, 1997, Detecting long-run abnormal stock returns: The empirical power and specification of the test statistics, Journal of Financial Economics 43, 301-372. Kothari, S.P. and Jerold Warner, 1997, Measuring long-horizon security price performance, Journal of Financial Economics 43, 301-339. Brown, Stephen and Jerold Warner, 1980, Measuring security price performance, Journal of Financial Economics 8, 205-258. Brown, Stephen and Jerold Warner, 1985, Using daily stock returns: The case of event studies, Journal of Financial Economics 14, 3-31. 4.2. Performance evaluation and mutual funds Kothari, S.P. and Jerold Warner, 2001. Evaluating mutual fund performance. Journal of Finance 56, 19852010. Dybvig, Philip and Stephen Ross, 1985, Differential information and performance measurement using a security market line, Journal of Finance 40, 383-399. Dybvig, Philip and Stephen Ross, 1985, The analytics of performance measurement using a security market line, Journal of Finance 40, 401-416. Sharpe, William F., 1992, Asset allocation: Management style and performance measurement, Journal of Portfolio Management, Winter, p. 7-19. Brown, Stephen and William Goetzmann, 1997, Mutual fund styles, Journal of Financial Economics 43, 373-399. Carhart, Mark, 1997, On persistence in mutual fund performance, Journal of Finance 52, 57-82. Malkiel, Burton, 1995, Returns from investing in equity mutual funds 1971 to 1991, Journal of Finance 50, 549-572. Daniel, Kent, Mark Grinblatt, Sheridan Titman, and Russ Wermers, 1997, Measuring mutual fund performance with characteristic-based benchmarks, Journal of Finance 52, 1035-1058. 4.3. Bayesian investors and Bayesian methods * Kandel, Shmuel and Robert Stambaugh, 1996, On the predictability of stock returns: An asset allocation perspective, Journal of Finance 51, 385-424. * Kothari, S.P. and Jay Shanken, 1997, Book-to-market, dividend yield, and expected market returns: A time-series analysis, Journal of Financial Economics 44, 169-203. Lewellen, Jonathan and Jay Shanken, 2002. Learning, asset-pricing tests, and market efficiency. Journal of Finance 57, 1113-1145. Stambaugh, Robert, 1997, Analyzing investments whose histories differ in length, Journal of Financial Economics 45, 285-331. Pastor, Lubos, 2000, Portfolio selection and asset pricing models, Journal of Finance 55, 179-223.

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Pastor, Lubos and Robert Stambaugh, 2000, Comparing asset pricing models: An investment perspective, Journal of Financial Economics 56, 335-381. Barberis, Nicholas, 2000, Investing for the long run when returns are predictable, Journal of Finance 55, 225-264. Xia, Yihong, 2000, Learning about predictability: The effect of parameter uncertainty on dynamic asset allocation, forthcoming in Journal of Finance. Zellner, Arnold, 1971, An Introduction to Bayesian Inference in Econometrics (John Wiley and Sons, New York, NY). Berger, James, 1985, Statistical Decision Theory and Bayesian Analysis (Springer-Verlag, New York, NY). Poirier, Dale, 1988, Frequentist and subjectivist perspectives on the problems of model building in economics, Journal of Economic Perspectives 2, 121-144. Efron, Bradley and Carl Morris, 1977, Stein’s paradox in statistics, Scientifc American (May), 119-127. Casella, George and Edward George, 1992. Explaing the Gibbs Sampler. American Statistician 46, 167174. Merton, Robert, 1987, A simple model of capital market equilibrium with incomplete information, Journal of Finance 42, 483-509. Detemple, Jerome, 1986, Asset pricing in a production economy with incomplete information, Journal of Finance 41, 383-391. Dothan, Michael and David Feldman, 1986, Equilibrium interest rates and multiperiod bonds in a partially observable economy, Journal of Finance 41, 369-382. Gennotte, Gerard, 1986, Optimal portfolio choice under incomplete information, Journal of Finance 41, 733-746. Williams, Joseph, 1977, Capital asset prices with heterogeneous beliefs, Journal of Financial Economics 5, 219-239. Jobson, J.D., Bob Korkie, and V. Ratti, 1979, Improved estimation for Markowitz portfolios using JamesStein type estimators, Proceedings of the American Statistical Association, 279-284. Jobson, J.D. and Bob Korkie, 1981, Putting Markowitz theory to work, Journal of Portfolio Management 7, 70-74. Jorion, Philippe, 1985, International portfolio decisions with estimation risk, Journal of Business 58, 259278. Jorion, Philippe, 1986, Bayes-Stein estimation for portfolio analysis, Journal of Financial and Quantitative Analysis 21, 279-292. 4.4. Closed-end funds Lee, Charles, Andrei Shleifer, and Richard Thaler, 1991, Investor sentiment and the closed-end fund

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puzzle, Journal of Finance 46, 75-109. Chen, Nai-fu, Raymond Kan, and Merton Miller, 1993, Are the discounts on closed-end funds a sentiment index?, Journal of Finance 48, 795-800. Chopra, Navin, Charles Lee, Andrei Shleifer, and Richard Thaler, 1993, Yes, discounts on closed-end funds are a sentiment index, Journal of Finance 48, 801-808. Pontiff, Jeffrey, 1995, Closed-end fund premia and returns: Implications for financial market equilibrium, Journal of Financial Economics 37, 341-370. 4.5. Home bias French, Kenneth and James Poterba, 1991, Investor diversification and international equity markets, American Economic Review 81, 222-226. Coval, Joshua and Tobias Moskowitz, 2000, Home bias at home: Local equity preference in domestic portfolios, Journal of Finance 54, 2045-2073. 4.6. Index addition Shleifer, Andrei, 1986, Do demand curves for stocks slope down?, Journal of Finance 41, 579-90. Harford, Jarrad and Aditya Kaul, 2000, Do concentrated trading equilibria exist? The migration of informed trading following index addition, Working paper (University of Oregon, Eugene, Oregon). 4.7. Location of trade anomalies Froot, Kenneth and Emil Dabora, 1999, How are stock prices affected by the location of trade?, Journal of Financial Economics 53, 189-216. Rosenthal, Leonard and Colin Young, The seemingly anomalous price behavior of Royal Dutch / Shell and Unilever N.V. / PLC, Journal of Financial Economics 26, 123-141. 4.8. Bubbles Stiglitz, Joseph, 1990, Symposium on bubbles, Journal of Economic Perspectives 4 (2), 13-18. Blanchard, Olivier and Mark Watson, 1982, Bubbles, rational expectations, and financial markets, in: Paul Watchel, ed., Crises in the Economic and Financial Structure (Lexington Books, Lexington, MA), 295315. Tirole, Jean, 1985, Asset bubbles and overlapping generations, Econometrica 53, 1071-1100. Hamilton, James and Charles Whiteman, 1985, The observable implications of self-fulfilling expectations, Journal of Monetary Economics 16, 353-373. Flood, Robert and Robert Hodrick, 1986, Asset price volatility, bubbles, and process switching, Journal of Finance 41 (4), 831-842.

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Diba, Behzad and Herschel Grossman, 1988, Explosive rational bubbles in stock prices?, American Economic Review 78 (3), 520-530. West, Kenneth, 1988, Bubbles, fads, and stock price volatility tests: A partial evaluation, Journal of Finance 43, 639-656. 5. SUMMARY AND PERSPECTIVE Fama, Eugene, 1991, Efficient capital markets: II, Journal of Finance 46, 1575-1617. Black, Fischer, 1986, Noise, Journal of Finance 41, 529-543. Campbell, John, 2000, Asset pricing at the millenium, Journal of Finance 55, 1515-1567. Ball, Ray, 1995, The theory of stock market efficiency: Accomplishments and limitations, Journal of Applied Corporate Finance 8, 4-17. Shleifer, Andrei, 2000, Inefficient Markets: An Introduction to Behavioral Finance (Clarendon Lectures in Economics, Oxford University Press Inc., New York). 6. APPENDIX: ECONOMETRICS Greene, William, 1997, Econometric Analysis, 3rd edition (Prentice Hall, Upper Saddle River, NJ). Hansen, Lars, 1982, Large sample properties of generalized method of moments estimators, Econometrica 50, 1029-1054. Nelson, Charles and Charles Plosser, 1982. Trends and random walks in macroeconomic time series. Journal of Monetary Economics 10, 139-162. Newey, Whitney and Kenneth West, 1987, A simple, positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix, Econometrica 55, 703-708. Schwert, G. William, 1987, Effects of model specification on tests for unit roots in macroeconomic data, Journal of Monetary Economics 20, 73-103. White, Halbert, 1980, A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity, Econometrica 48, 817-838. White, Halbert, 1984, Asymptotic theory for econometricians (Academic Press, Orlando, FL). Hamilton, James, 1994, Time Series Analysis (Princeton University Press, Princeton, NJ). James, W. and Charles Stein, 1961, Estimation with quadratic loss, Fourth Berkeley Symposium on Mathematical Statistics and Probability (University of California Press, Berkeley, CA). Phillips, P.C.B., 1991, To criticize the critics: An objective Bayesian analysis of stochastic trends, Journal of Applied Econometrics 6, 333-364.

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