B9311 Professor Lars A.

Lochstoer
B9311Asset Pricing II Spring 2013 Course Outline and Syllabus

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Contact Information: Professor Lars A. Lochstoer Uris Hall 405B Phone: 851-2119 Email: LL2609@columbia.edu Office Hours: Please email for an appointment. Description This is the second of a two course sequence that examines the asset pricing side of financial economics. The course will focus on the development of stylized facts and tools for the investigation of data, while the first course covered more theoretical aspects of asset pricing. The asset pricing field is vast, but we will focus primarily on two core ideas: 1. time-series properties of asset returns (predictability, volatility, correlations with other variables, etc.) 2. cross-sectional properties of asset returns implied by equilibrium asset pricing models (including CAPM, consumption-based asset pricing, factor models, etc.) Well also examine the bond market and look at some simple term structure models, as well as the pricing of equity index derivative securities. Finally, we will discuss some recent research on the commodity futures markets. We will use a variety of econometric techniques, including GMM and maximum likelihood, as well as various time-series models. We view these econometric techniques as a way of answering economic questions, rather than being interested in the econometric methodology per se. Prerequisites The course is designed for second year doctoral students in finance. The prerequisites are Finance Theory I, Asset Pricing Theory, Intro to Econometrics, and an additional upper level Econometrics class (Financial Econometrics, Time Series Analysis, or similar). Materials I will distribute lecture notes in class. You are required to yourself download and, if you want, print copies of any journal articles that we will cover. References are given in the back of this document, and I will in class let you know which articles we will focus on for each class. We will read substantial parts of the following book: Cochrane, John, 2005, Asset Pricing: Revised Edition Princeton, NJ: Princeton University Press It is referred to as (AP) in the reading list.

B9311 Professor Lars A. Lochstoer

Other excellent reference books are the following:

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Campbell, John Y., Andrew W. Lo, and A. Craig MacKinlay, 1997, The Econometrics of Financial Markets, Princeton, NJ: Princeton University Press Duffie, Darrell, 2001, Dynamic Asset Pricing Theory, 3rd Edition, Princeton, NJ: Princeton University Press Singleton, Kenneth J., 2006, Empirical Dynamic Asset Pricing, Princeton, NJ: Princeton University Press Hamilton, James D., 1994, Time Series Analysis, Princeton, NJ: Princeton University Press You will need access and be willing to work in MatLab, Gauss or some other matrix programming language in order to solve the weekly problem sets. The Reading List includes both classic papers and newer material to give you an idea of how people are approaching the subject more recently. Requirements There will be substantial required homework assignments, and many of them will involve empirical work. In the last half of the class, you will in addition work on your own research proposal due at the end of the term. More information on this project will be given in class. Class participation is mandatory. You are expected to be prepared to discuss and answer questions related to the homework assignments and the required readings. There will be a final exam. Class Schedule We meet every Wednesday 4:15 7:00pm in 415 Warren from Jan. 30 to May 1, with the exception of the following dates. March 13 and March 20 (Business school first exam period and spring break, respectively). In addition, we have to reschedule the classes of February 20th, February 27th, and April 10th as I am giving talks at universities those dates. We will decide on alternative dates and times in class.

B9311 Professor Lars A. Lochstoer

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Tentative Reading List

We may deviate from this reading list. I will let you know about any such deviations in class.

1. The CAPM and an econometric review a. Methodology: CAPM, OLS, and early tests of the CAPM Any source to review CAPM theory. In AP, it is Ch. 9, but this chapter depends on Chapters 4, 5, and 6 as well. Time-series tests: Gibbons, Ross and Shanken (1989). AP Ch. 12. Cross-sectional tests: AP pp. 434 - 452. Other references: Shanken (1987), Shanken (1992), Black, Jensen, and Scholes (1972), Fama and MacBeth (1973)

b. Landmark critique of the unconditional CAPM Fama and French (1992)

c. Methodology: review of asymptotics for OLS and robust standard errors Any graduate-level econometrics textbook (e.g., Hamilton, referenced above).

2. Multifactor models I: Methodology, linear K-factor models, and anomalies a. The Fama-French Model and critiques Fama and French (1993) AP Ch. 9 MacKinlay (1995) Lo and MacKinlay (1990) Berk (1995) Daniel and Titman (1997)

b. General linear factor models AP Ch. 13

c. Anomalies and establishing a new stylized fact Momentum: Jegadeesh and Titman (1993), Asness, Moskowitz, and Pedersen (2012), Daniel and Moskowitz (2012) Liquidity: Pastor and Stambaugh (2003)

B9311 Professor Lars A. Lochstoer Idiosyncratic volatility: Ang, Hodrick, Xing, and Zhang (2006, 2009)
Social networks: Cohen, Frazzini, and Malloy (2008) Inattention: Cohen and Frazzini (2008)

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d. Factor models and fund performance measurement Background reading: Carhart (1997), Berk and Green (2004) Mutual fund performance: Kosowski, Timmermann, Wermers, and White (2006) Hedge fund performance: Fung, Hsieh, Ramadorai, and Naik (2008)

3. Time-series properties of aggregate returns and dividends: Predictability AP Ch. 20.1 Shiller (1981) Fama and French (1989) Campbell and Shiller (1988) Lettau and Ludvigsson (2001a) Hodrick (1992) Stambaugh (1999) Boudoukh, Michaely, Richardson, and Roberts (2007) Ang and Bekaert (2006) Cochrane (2008, 2011) Pastor and Stambaugh (2009) Kelly and Pruitt (2012)

4. Beyond the unconditional CAPM a. Conditional linear factor models AP Ch. 8. Lettau and Ludvigsson (2001b) Lewellen and Nagel (2006), Daniel and Titman (2012), Nagel (2012) Other references: Jagannathan and Wang (1996), Ferson and Harvey (1999), Petkova and Zhang (2005)

b. Value, growth, and duration Campbell (1991) Campbell and Mei (1993) Dechow, Sloan, and Soliman (2004) Campbell and Vuolteenaho (2004) van Binsbergen, Brandt, and Koijen (2010) Other references: Campbell (1993), Cohen, Polk, and Vuolteenaho (2003), Cohen, Polk, and Vuolteenaho (2006), Lettau and Wachter (2007)

B9311 Professor Lars A. Lochstoer

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5. Methodology: GMM tests of models with an observable stochastic discount factor Hansen and Singleton (1982) AP Ch. 10, 11 Nagel and Singleton (2011) Other references: Hansen, Heaton and Yaron (1996)

Required reading (although you do not need to follow in detail all of the math in the Hansen papers, especially when nonnegativity is imposed). The Jagannathan and Wang paper was suggested reading earlier in the semester. Here it is included because it develops an estimation methodology for the HJ-distance. Hansen and Jagannathan (1991) Hansen and Jagannathan (1997) AP The material on H-J bounds in Chapter 5, and Chapters 13 - 16 (they are short chapters) Jagannathan and Wang (1996) Hodrick and Zhang (2001) Li, Xu, and Zhang (2010) We will not discuss this related paper. It works out the econometrics of the HJ-distance when the null is that the econometrician has the wrong stochastic discount factor. Hansen, Heaton, and Luttmer (1995)

6. Consumption-based asset pricing The standard Consumption CAPM (CCAPM) and general background material: AP Ch. 21, Campbell (2003), Working (1960), Parker and Julliard (2005) The conditional CCAPM (e.g., habit): Lettau and Ludvigsson (2001b) Long-run risk: Bansal, Kiku and Yaron (2007) Euler equation errors: Lettau and Ludvigson (2009) Heterogeneous agents: Vissing-Jorgensen (2002), Mankiw and Zeldes (1991) Heterogeneous goods: Yogo (2006), Piazzesi, Schneider, and Tuzel (2007), Lochstoer (2009) Consumption disaster risk: Barro, Nakamura, Steinsson, and Ursua (2009) Learning: Johannes, Lochstoer, and Mou (2011) Other references: Mehra and Prescott (1985), Campbell and Cochrane (1999), Bansal and Yaron (2004), Rietz (1988), Barro (2009).

7. Equity volatility, equity index derivatives, and their implications for GE models Schwert (1989)

B9311 Professor Lars A. Lochstoer Bekaert and Wu (2000) Broadie, Chernov, and Johannes (2007) Broadie, Chernov, and Johannes (2009) Backus, Chernov, and Martin (2009) Drechsler and Yaron (2010)

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8. (Some) Financial frictions Funding liquidity Betting on Beta: Frazzini and Pedersen (2010) Embedded leverage: Frazzini and Pedersen (2011) Limits to arbitrage and market segmentation: Evidence from commodity markets Some background: Sundaresan (1981), Fama and French (1986). Facts and Fantasies: Gorton and Rouwenhorst (2006) Speculator capital: Etula (2010), Tang and Xiong (2010), Mou (2010) Producer hedging and commodity prices: Acharya, Lochstoer, and Ramadorai (2010)

9. What is total wealth and does it matter? Heaton and Lucas (2000) Moskowitz and Vissing-Jorgensen (2002) Campbell (1996) Santos and Veronesi (2005)

10. Explaining asset price innovations: news or ? a. News: Roll (1984) (see also Boudoukh, Richardson, Shen and Whitelaw (2007)) French and Roll (1986) Kothari and Shanken (1992) Tetlock (2008) b. Inattention: Huberman and Regev (2001) Tetlock (2010) Gilbert, Kogan, Lochstoer, and Ozyildirim (2012)

11. The term structure a. Motivation and some facts:

B9311 Professor Lars A. Lochstoer AP, Chapter 19 Litterman and Scheinkman (1991) Campbell and Shiller (1991) Bekaert and Hodrick (2001) Cochrane and Piazzesi (2006), Cieslak and Povala (2011) Bekaert, Hodrick, and Marshall (2001)

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b. Formal modeling: A good background source on this topic include Piazzesi (2003)

We will discuss some features of the following papers Dai and Singleton (2000) Duffee (2002) Ang and Piazzesi (2003) Duffee (2010)

c. Pricing both equity and bonds in an affine no-arbitrage framework Lettau and Wachter (2012) Koijen, Lustig and van Nieuwerburgh (2010)

References
[1] Acharya, Viral, Lars Lochstoer, and Tarun Ramadorai, 2013, Limits to arbitrage and hedging: Evidence from commodity markets, forthcoming Journal of Financial Economics. [2] Andersen, Torben G., and Jesper Lund, 1997, Estimating continuous-time stochastic volatility models of the short-term interest rate, Journal of Econometrics 77, 343 377. [3] Ang, Andrew, and Geert Bekaert, 2006, Stock return predictability: Is it there?, Forthcoming Review of Financial Studies. [4] Ang, Andrew, and Joseph Chen, 2003, CAPM over the long-run: 1926 2001, Working paper, Columbia GSB. Forthcoming Journal of Empirical Finance. [5] Ang, Andrew, and Monika Piazzesi, 2003, A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables, Journal of Monetary Economics 50, 745 787. [6] Ang, Andrew, Robert Hodrick, Yuhang Xing, and Xiaoyan Zhang, 2006, "The Crosssection of Volatility and Expected Returns," Journal of Finance 61, 259 299. [7] Ang, Andrew, Robert Hodrick, Yuhang Xing, and Xiaoyan Zhang, 2009, "High Idiosyncratic Volatility and Low Returns: International and Further U.S. Evidence," Journal of Financial Economics 91, 1 23. [8] Asness, Cliord, Tobias Moskowitz, and Lasse Pedersen, 2012, "Value and Momentum Everywhere," Forthcoming, Journal of Finance. [9] Backus, D., Mikhail Chernov, and Ian Martin, 2010, Disasters implied by equity index options, forthcoming Journal of Finance. [10] Bansal, Ravi, and Amir Yaron, 2004, Risks for the long run: A potential resolution of the equity premium puzzle, Journal of Finance 59, 1481 1509. [11] Bansal, Ravi, Robert F. Dittmar, and Christian T. Lundblad, 2005, Consumption, Dividends, and the Cross-Section of Equity Returns, Journal of Finance 60, 1639-1672. [12] Bansal, Ravi, Dana Kiku, and Amir Yaron, 2006, Risks for the Long Run: Estimation and Inference, Duke, Working paper.

[13] Barclay, Michael J., Robert H. Litzenberger, and Jerold B. Warner, 1990, Private information, trading volume, and stock-return variances, Review of Financial Studies 3, 233 253. [14] Bekaert, Geert and Robert J. Hodrick, 2001, Expectations Hypotheses Tests, Journal of Finance 56, 1357 1394. [15] Bekaert, Geert, and G. Wu, 2000, Asymmetric Volatility and Risk in Equity Markets, Review of Financial Studies 13, 1-42. [16] Bekaert, Geert, Robert J. Hodrick, and David Marshall, 1997, On Biases in Tests of the Expectations Hypothesis of the Term Structure of Interest Rates, Journal of Financial Economics 44, 309-348. [17] Berk, Jonathan B., 1995, A critique of size-related anomalies, Review of Financial Studies 8, 275 286. [18] Berk, Jonathan, and Richard Green, "Mutual Fund Flows and Performance in Rational Markets," Journal of Political Economy 2004, 1269 1295. [19] Bibkov, Ruslan, and Mikhail Chernov, 2006, No-Arbitrage Macroeconomic Determinants of the Yield Curve, working paper, Columbia Business School. [20] van Binsbergen, Jules, Michael Brandt, and Ralph Koijen, 2010, On the Timing and Pricing of Dividends, working paper Booth School of Business, University of Chicago. [21] Black, Fischer, Michael C. Jensen, and Myron Scholes, 1972, The capital asset pricing model: Some empirical tests, in Michael C. Jensen, ed., Studies in the Theory of Capital Markets, 79 121 (Praeger, New York). [22] Boguth, O., M. Carlson, A. Fisher, and M. Simutin, "Conditional Risk and Performance Evaluation: Volatility Timing, Overconditioning, and New Estimates of Momentum Alphas." Working Paper, University of British Columbia. [23] Boudoukh, Jacob, Matthew Richardson, YuQing Shen, and Robert F. Whitelaw, 2005, Do asset prices re ect fundamentals? Freshly squeezed evidence from the FCOJ market, Working paper, Stern School, NYU.

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[24] Boudoukh, Jacob, Roni Michaely, Matthew Richardson, Michael Roberts, 2007, On the Importance of Measuring the Payout Yield: Implications for Empirical Asset Pricing, Journal of Finance 62, 877 915. [25] Brav, Alon, George M. Constantinides, and Christopher C. Geczy, 2002, Asset pricing with heterogeneous consumers and limited participation: Empirical evidence, Journal of Political Economy 110, 793 824. [26] Brodie, Mark, Mikhail Chernov, and Michael Johannes, 2007, Model specication and risk premia: evidence from futures options, Journal of Finance 62, 1453 1490. [27] Brodie, Mark, Mikhail Chernov, and Michael Johannes, 2009, Understanding index option returns, Review of Financial Studies XX, XX. [28] Brown, Stephen J., and Jerold B. Warner, 1985, Using daily stock returns: The case of event studies, Journal of Financial Economics 14, 3 31. [29] Brown, Stephen J., William N. Goetzmann, and Stephen A. Ross, 1995, Survival, Journal of Finance 50, 853 873. [30] Campbell, John Y., 1991, A variance decomposition for stock returns, Economic Journal 101, 157 179. [31] Campbell, John Y., 1993, Intertemporal asset pricing without consumption data, American Economic Review 83, 487 512. [32] Campbell, John Y., and Jianping Mei, 1993, Where do betas come from? Asset price dynamics and sources of systematic risk, Review of Financial Studies 6, 567 592. [33] Campbell, John Y., 1999, Asset prices, consumption, and the business cycle, in J. B. Taylor and M. Woodford, Eds., Handbook of Macroeconomics, Volume 1C, Elsevier Science B.V., Amsterdam. [34] Campbell, John Y., and John H. Cochrane, 1999, By force of habit: A consumptionbased explanation of aggregate stock market behavior, Journal of Political Economy 107, 205 251. [35] Campbell, John Y., Martin Lettau, Burton G. Malkiel, and Yexiao Xu, 2001, Have individual stocks become more volatile? An empirical exploration of idiosyncratic risk, Journal of Finance 56, 233-264.

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[49] Cohen, Randolph B., Christopher Polk, and Tuomo Vuolteenaho, 2006, The price is (almost) right, working paper, London School of Economics. [50] Constantinides, George M., and Du e, Darrell. Asset Pricing with Heterogeneous Consumers.Journal of Political Economy 104 (April 1996): 219 40. [51] Dai, Qiang, and Kenneth J. Singleton, 2000, Specication analysis of a ne term structure models, Journal of Finance 55, 1943 1978. [52] Daniel, Kent, and Tobias Moskowitz, 2012, "Momentum Crashes," Working paper Columbia University. [53] Daniel, Kent, and Sheridan Titman, 1997, "Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," Journal of Finance 52, 1 33. [54] Daniel, Kent, and Sheridan Titman, 2012, "Testing Factor-Model Explanations of Market Anomalies, with Sheridan Titman. Critical Finance Review, 1(1), January 2012, pp 103-139. [55] Dechow, Patricia M., Richard G. Sloan, and Mark T. Soliman, 2004, Implied equity duration: A new measure of equity risk, Review of Accounting Studies 9, 197 228. [56] Drecshler, Itamar, and Amir Yaron, 2011, What s vol go to do with it?, Review of Financial Studies 24, 1 45. [57] Duee, Gregory R., 2002, Term premia and interest rate forecasts in a ne models, Journal of Finance 57, 405 443. [58] Duee, Gregory R., 2004, Time-variation in the covariance between stock returns and consumption, Journal of Finance, forthcoming. [59] Duee, Gregory R., 2006, Term structure estimation without using latent factors. Journal of Financial Economics 79, 507 536. [60] Fama, Eugene F., and Kenneth R. French, 1989, Business conditions and expected returns on stocks and bonds, Journal of Financial Economics 25, 23 49. [61] Fama, Eugene F., and Kenneth R. French, 1992, The cross-section of expected returns, Journal of Finance 47, 427 465.

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[75] Frazzini, Andrea, and Lasse Pedersen, 2011, Embedded Leverage, NYU working paper. [76] French, Kenneth R., and Richard Roll, 1986, Stock return variances: The arrival of information and the reaction of traders, Journal of Financial Economics 17, 5 26. [77] Fung, William, David Hsieh, Narayan Naik, and Tarun Ramadorai, 2008, "Hedge Funds: Performance, Risk, and Capital Formation," Journal of Finance 63, 1777 1803. [78] Gibbons, Michael R., Stephen A. Ross, and Jay Shanken, 1989, A test of the e ciency of a given portfolio, Econometrica 57, 1121 1152. [79] Gilbert, Thomas, Shimon Kogan, Lars Lochstoer, and Ataman Ozyildirim, 2012, Investor Inattention and the Market Impact of Summary Statistics, Management Science .58, pp 336-350. [80] Grundy, Bruce D., and J. Spencer Martin, 2001, Understanding the nature of the risks and sources of the rewards to momentum investing, Review of Financial Studies 14, 29 55. [81] Guvenen, Fatih, "A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation or Cross-sectional Heterogeneity?" (December 27, 2004). Available at SSRN [82] Hansen, Lars P., John Heaton, and Erzo G.J. Luttmer, 1995, Econometric evaluation of asset pricing models, Review of Financial Studies 8, 237 274. [83] Hansen, Lars P., John Heaton, and Amir Yaron, 1996, Finite-Sample Properties of Some Alternative GMM Estimators, Journal of Business & Economic Statistics 14, 262 280. [84] Hansen, Lars P., and Ravi Jagannathan, 1991, Implications of security market data for models of dynamic economies, Journal of Political Economy 99, 225 262. [85] Hansen, Lars P., and Ravi Jagannathan, 1997, Assessing specication errors in stochastic discount factor models, Journal of Finance 52, 557 590. [86] Hansen, Lars P., and Kenneth J. Singleton, 1982, Generalized instrumental variables estimators of nonlinear rational expectations models, Econometrica 50, 1269 1286.

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