Website for 35904 Asset Pricing
John H. Cochrane, Fall 2011
Last update 12/16/2011
I. Announcements:
Class meets TR 10:30 AM-12:00 PM in the aptly-named Lehman Brothers Classroom HCC02 The final exam is Tuesday Dec 6 10:30-1:20 in the same room. Class will meet on Thursday Sept. 22 just like all other booth classes.
The TA for the class is Yoshio Nozawa, ynozawa@chicagobooth.edu. The review session is Tuesday 4:45-5:45 3A
Please send me an email if you are going to take the class, but will not be registered as a GSB student (or even if you are, just to be sure). I want to build an email list of students in the class so I can send announcements.
It’s important to hit “Refresh” on your browser so you see any new items here, not the version of the webpage in your cache.
II. Course Policies
This course is a survey of asset pricing theory, emphasizing a discount-factor and GMM approach. The discount factor is a unifying framework: p=E(mx) covers everything, stocks, bonds, options, real investments, discrete time, continuous time, asset pricing, portfolio theory, etc.
The course requirements are 1) Show up, read the book and papers, and participate in class discussion. 2) Do problem sets. 4) Take a final exam. The grade will be based on max(25% problem sets + 75% exam, 100% exam) plus class participation. If you want me to learn your name and get class participation credit bring a name card and use it. If you don’t bring a name card to class and get your picture in the Booth acebook, don’t complain that faculty don’t know who you are. You may help each other on problem sets, but I expect everyone to actually do the work. MBAs may work in groups. You may not hand in problem sets late.
Prerequisites. I design the course for Booth PhD students who have taken a year of PhD level economics and econometrics. I also plan for economics department students who have taken the core exam. I encourage students to take 35901 (Fama) before or with this class. Facts motivate theory, and that background will make all this fall into place much better.
In general, you should have some Ph.D.-level macroeconomics, finance or statistics/econometrics before taking this course. I will use without much fanfare concepts like a representative consumer and dynamic program (macroeconomics); expected returns, betas, and facts about returns like predictability (finance); and basic time series tools like autocorrelations, VAR models, diffusion models. MBA students are welcome, with the understanding that the course assumes the above background.
There is one required text: Asset Pricing, Princeton University Press. I recommend the Revised Edition of Asset Pricing since I got rid of the typos, but you can use the first edition if you already have it and want to save some money. Here’s the Typo list for first edition of Asset Pricing. (If you’re using the second edition, these have all been fixed) The list below includes some references, which are the "classic originals" you should at least know about. Some other references are papers that I will lecture on, but do not require you to read the whole paper from beginning to end. I will also post occasional notes here when my lectures stray from the book.
Communication: Everything will be posted on the class website. Make sure you sign up for the email list so you get news about typos etc.. I’m in HC 459, 702-3059, john.cochrane@chicagobooth.edu
II. Schedule and reading list:
Please do the indicated required readings before class.
Week 0. Vital
Background
1. You need to be comfortable with time series mechanics. Start with the Appendix on Continuous time in Asset Pricing, p.489-496. Read the Continuous time review notes for a quick refresher on dz and dt. I will use dz and dt and Ito's lemma on the first day, so make sure you understand this. (I won’t use the forward and backward equations right away.) My Time series notes are a more leisurely refresher of discrete-time time-series mechanics.
2. You need to know facts: predictability, value premium, etc., especially if you haven’t taken Fama’s class yet.
Read Asset Pricing Ch 20 389-393, and 426-454 to have some idea of why we're doing all this stuff. Section 2 of Financial Markets and the Real Economy p. 244-256 is a recent simpler treatment.
If you don’t know it already, read one classic paper: Fama and French, “Multifactor explanations of asset pricing anomalies”. We’ll talk a lot about the “Fama-French three factor model” as the paradigm of current multifactor models in expected return-beta form.
3. Read "Discount Rates" This is my latest effort to put in one place all the facts, theory, philosophy and directions for new research in asset pricing. It gives you a sense of the bigger picture, why we do what we do and where we're heading. I may be wrong, but you have to form a view of the big picture, and thinking about why I'm wrong is a good place to start.
Week 1. Basic model, Overview, Equity premium.
1. Asset Pricing Ch1-2 and Ch 21.1 for equity premium
2. (Optional, reference) The classic paper: Lucas, Robert E. Jr, 1978, “Asset Prices in An Exchange Economy’’ Econometrica 46, 1429-1455. This is the famous paper that launched the consumption-based model and endowment-economy framework.
Week 2. (Oct 6, 11) Contingent claims, state-space representation and existence of a discount factor
1. Asset Pricing Ch. 3-4
2. (Optional, reference) Hansen, Lars Peter and Scott F. Richard, 1987, “The Role of Conditioning Information in Deducing Testable Restrictions Implied by Dynamic Asset Pricing Models” Econometrica 55, 587-613. This is the paper that sets out all of the state space stuff, and the conditional vs. unconditional mean variance frontier. It has all the assumptions and the proofs. Very dense, and I mean that as a compliment.
Week 3. (Oct 13, 18) Mean-variance frontier, beta representations, conditioning information.
1. Asset Pricing Ch 5-8.
Week 4. (Oct. 20) Factor pricing models.; CAPM, ICAPM, APT
1. Asset Pricing Ch.8-9.
Week 5. (Oct 25) GMM
1. Asset Pricing Ch 10-11.
2. (Optional, reference) Hansen, Lars Peter, 1982, “Large
Sample Properties of Generalized Method of Moments Estimators” Econometrica 50, 1029-1054. This paper has the GMM
distribution theory and assumptions. Read along with
3. (Optional, reference) Hansen, Lars Peter, and Kenneth J. Singleton, 1982, “Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models” Econometrical 50 1269-1286.; Errata Applies GMM to the consumption-based model. The “how-to” paper accompanying the last paper. The Errata tables are the right ones. Notice the equity premium puzzle in the stock-bond estimation. Moral: plot your data.
Week 6. (Oct 27) Regression tests, GRS, and GMM
1. Asset Pricing Ch 12-16
2. (Optional, reference) Fama and French, “Multifactor explanations of asset pricing anomalies”. A good paper to keep in mind as an application of all this technique. I’ll focus on the basic tests in Tables 1-2 as the classic example of "how to do cross-sectional tests."
Week 7. (Nov, 1, 3) a) Option pricing and b) Term structure definitions, expectations hypothesis and factor structure.
1. Asset Pricing Ch 17;
Week 8. (Nov.8) Term structure models
1. Asset Pricing
2 Lecture notes. Part 1 Part 2 (These are old versions, I'll note here when they are updated.)
2. (Optional, Reference ) “Bond Risk Premia” (its Appendix) and Decomposing the Yield Curve with Monika Piazzesi. Bond risk premia is our update of the Fama-Bliss facts. Decomposing the Yield curve is our best shot to put these insights into an affine model with risk premia.
Week 9. (Nov. 10, 15) Portfolio theory.
1.“Portfolio Theory” This is a draft for a chapter of the next Asset Pricing revision.
2. (Optional, reference) “Portfolio Advice for a Multifactor World" An early explanation of how all the new facts in finance change how we do portfolios.
3. (Optional, Reference) A Mean-Variance Benchmark for Intertemporal Portfolio Theory. I think in the end we should think about prices and payoffs, not returns, and this is a first attempt. Mean-variance theory can apply despite all sorts of conditioning information.
Week 9-10. (Nov 17, 22, 29, Dec. 1) Asset pricing and macro. Alternative utility functions: multiple goods, aggregation, habits, durable goods, labor, recursive utility, long run risks, endowment and general equilibrium models, production and investment.
1.Asset Pricing Ch 21.2
2.Sections 4 and 6 of Financial Markets and the Real Economy p.267-290, 302-314.
References: There's a lot here. You're responsible for what's in lecture, not the details of all these papers. However, I will show the main results and this is a written resource. Figure out when to stop reading.
3. (Get the idea, math not necesary!) Two Trees (with Francis Longstaff and Pedro Santa-Clara), Review of Financial Studies 21 (1) 2008 347-385 An endowment economy with two trees. It follows up on the idea that "we can't all rebalance." There's a thesis topic in adding adjustment costs to this model.
4. International Risk Sharing is Better Than You Think, Or Exchange Rates are Too Smooth with Michael Brandt and Pedro Santa Clara. Journal of Monetary Economics 53 (4) May 2006 671-698. Discount factors and HJ bounds across countries, and an introduction to international.
5. “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior” Journal of Political Economy, 107, 205-251 (April 1999) (With John Y. Campbell). The book summary will be enough, but here's the whole thing, and Manuscript with extra appendices
One paper on Recursive utility?
(Optional) My webpage. Of course you should read everything on this!
III. Problem sets
Note: the filenames and problem set numbers don't necessarily match. I told too many jokes and got a week behind.
Problem set 1 Added 9/23
Problem set 2 Added 10/5
Problem set 3 Added 10/12, due 10/18.
Problem set 4 Added 10/19 due 10/25
Problem set 5 Added 10/26 Due 11/1
Problem set 6 Added 11/2 Due 11/8
Problem set 7 The Data file Due 11/15
Problem set 7 answers matlab program function doit function min2
Problem set 8 due 11/22 factors data returns data
Problem set 8 answers matlab program function tsregress_gmm function olsgmm_ps6 function cs_gmm
Problem set 9 due 11/29
Problem set 9 answers
matlab program
Sample final exam Warning! This is the final from the last time I taught the course. I have not reviewed the questions or answers for accuracy, and consistency with how I taught the course this year. This is mostly to help you see the style of final exams.
Final exam score distribution:
