This page is devoted to the book Asset Pricing,
and the corresponding online class.
You can find lecture notes, class notes, readings, and problem sets at the "teaching" link to the left, especially
35150 Advanced Investments and
35904 Asset Pricing. Note, the answers to many problem sets are intentionally not posted.
I may fix that some day
but it's a big project. Notes related to macroeconomics and time series are on the "research" page.
Asset pricing Revised Edition. This link gives you a sample chapter. Click here to go to the Princeton University press website where you can order the book. (It is sometimes cheaper at Amazon.com or Barnes and Noble.com. In Chicago, it’s available at the seminary COOP bookstore.) I will send problem set solutions
to people who are teaching a class that uses the book, but not for self-study, or
for students who want help on their problem sets (!)
The online class is back! (September 2017). Coursera tried to kill it,
but it is now migrated over to Canvas.
to go to the online class. It should be open and free to anyone, including
all the quizzes, problem sets and exams. Since it's on the Canvas system,
if you are teaching at a University that uses Canvas, you should be able
to integrate it with your class, assign all or part of it, and receive grades
from quizzes and problem sets. Thus, you can use it as a flipped classroom,
assign selected videos and quizzes in advance of a lecture. It is also ideal
for a PhD program summer school for year 0 or year 1. Again, through canvas
you should be able to assign the class, in whole or in part, and get grades.
It's also well suited to self-study. If you just want to watch the videos
and read the notes, they are all here via youtube links below.
Huge thanks to Emily Bembeneck and Allison Kallo at the University of Chicago,
Mikhail Proshletsov, and above all to Nina Karnaukh now at Ohio State.
Nina masterminded all the hard work of moving the class pages and quizzes from
the Coursera system to the Canvas system, and fixing innumerable glitches along
the way. Thanks also to the Booth School for paying for the transition.
Here are some additional materials useful for classes or self study. Many of these are essays or notes that I wrote since
last revising the book.
- If you are teaching a class that uses Asset Pricing, you can get solutions to the
problems by emailing me. Tell me who you are and what class you're teaching.
- Here's the Typo list for the first edition.
These typos are all removed in the revised edition.
- Portfolio theory is a draft of a Chapter on portfolio theory
for the next edition.
- The Introduction to "Financial Markets
and the Real Economy" is an updated survey of macro-asset pricing work.
- Discount rates (Journal of Finance) is my latest attempt to synthesize asset pricing and suggest
where we should go.
2017. Review of Finance 21(3): 945-985. Links:
Publisher (doi) ,
Last manuscript. I survey many current
frameworks including habits, long run risks, idiosyncratic risks, heterogenous preferences,
rare disasters, probability mistakes, and debt or institutional finance.
- Continuous time. Note covering dz, dt, stochastic integrals,
and how to do all of Chapter 1 in continuous time. (The next revision will use a continuous time framework much more extensively.) This is better than the current continuous time chapter of Asset Pricing
linear models Foundations and Trends in Finance 6 (2011), 165–219 DOI: 10.1561/0500000037
Manuscript How to do ARMA models, opreator tricks, and Hansen-Sargent prediction formulas in continuous time.
- A Brief Parable of Overdifferencing January 2012.
This is a short note, showing how money demand estimation works very well in levels or long (4 year) differences, but
not when you first-difference the data. It shows why we often want to run OLS with corrected standard errors rather than GLS or ML,
and it cautions against the massive differencing, fixed effects and controls used in micro data. It's from a PhD class, but I thought the reminder worth a little standalone note.
- Investments notes. Jan 2005. Notes for MBA investments classes.
Summary of background (statistics, regression, time series, matrices, maximization) and a concise treatment of some of the standard topics
(bond notation and expectations hypothesis, bond pricing)
- Time series for macroeconomics and Finance Jan 2005 Lecture notes for
PhD time series course. This revision finally includes the figures!
- Writing tips for PhD students May 2005.
Some tips on how to write academic articles. Do as I say, not as I do.
Chinese Translation, 2013.
(Original source of chinese translation. Thanks to Shihe Fu)
The lecture videos are available on two youtube channels,
The numbering in the videos is the same as the modules here.
Course Outline and Materials
You can see the detailed topic list in the youtube videos.
If you can't get some of the papers, because you don't have JSTOR or scence direct,
a little googling will usually turn it up. I can't list unofficial links here.
Module 1. Stochastic Calculus Introduction and Review.
This module is a review covering some basic concepts in stochastic calculus and time-series processes. Skim if you know this material well.
- Required reading
- Optional or background reading
- Asset Pricing: Preface
- Investments notes.
A review of my introductory class for MBAs. Useful cultural background and reference.
- Time series notes.
This is a book-length introduction to time series in discrete time. You don't need all of it here but it is one place to find the basics.
- Youtube videos 1.x
- Whiteboards (the whiteboards behind me in lecture)
Module 2. Facts
This week is an overview of asset pricing facts and the basic theory that we will expand on throughout the course.
Module 3. Classic Issues
This week we'll cover some of the classic issues in finance.
Module 4. Discount Factor
This week we'll look at the discount factor in more detail.
Module 5. Mean-variance frontier and beta representations.
This week we'll cover the mean-variance frontier, beta representations, and
the relationship between the discount factor, mean-variance and beta representations,
and conditioning information.
Module 6. Factor Pricing Models
This week we'll cover the some of the common factor models used in asset pricing:
the Capital Asset Pricing Model (CAPM), the Intertemporal Capital Asset Pricing Model (ICAPM),
the Arbitrage Pricing Theory (APT), and how they relate to each other.
Module 7. Econometrics and GMM.
This week we'll discuss the Generalized Method of Moments.
How do you estimate alphas, betas, and lambdas?
How do you evaluate if models are any good?
GMM is a very flexible econometric framework for lots of problems,
and we'll also explore that a bit
- Required Reading
- Asset Pricing Chapter 11
- Asset Pricing Chapter 12
- Optional Reading
- Hansen, Lars Peter, 1982, Large Sample Properties of Generalized Method of Moments Estimators Econometrica 50, 1029-1054.
- Hansen, Lars Peter and Kenneth J. Singleton, 1982, Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models Econometrica 50, 1269-1286.
- Cochrane, John H. GMM Notes
- Cochrane, John H., A Brief Parable of Overdifferencing
- Guide to the optional readings:
- Hansen 1982 is The Article that defines GMM. Read it (at least) three times. The first time through, just understand the notation and the statement of the theorems. Find the GMM estimate defined, standard errors, test statistics. Get ready to use GMM. The second time through, read the "if" part of the proofs. Understand the stationarity, ergodicity, etc. assumptions. They matter! Finally, try to read the proofs.
- Hansen and Singleton (1982) is the crucial application to the consumption based model.
- GMM Notes is a written version of my notes for the lectures. It's not exactly one to one, I condensed the lectures. The lectures and pdfs of the whiteboards should be enough. This is one place to turn if those are confusing, and hence just an optional resource.
- The Brief Parable of Overdifferencing is a good example for the "Choosing a W matrix" lecture, showing you how statistical efficiency can lead to bad estimators.
- Youtube videos 7.x
Module 8. Fama-French and Performance Evaluation
In this module, we'll discuss two of the most classic uses of factor pricing models.
We start with the Fama-French three-factor model and the most common fourth factor
added to it (momentum).
Then we'll study the question whether mutual fund managers have "skill" revealed in "alpha."
That question has us benchmark the managers against factor pricing models.
- Fama / French Readings
- Fama and French, 1996, "Multifactor Explanations of Asset Pricing Anomalies", p. 55-84. Skip section V, 68-75.
- Cochrane, John H., "Presidential Address: Discount Rates" The Journal of Finance 66, 1047-1108. Read Section II "Cross-Section" p. 1058-1063.
- Asset Pricing Chapter 20.2. My "textbook" treatment of the Fama-French model and what it means.
- Performance Evaluation Readings
- Carhart, Mark M., 1997, “On Persistence in Mutual Fund Performance,” Journal of Finance 52, 57-82.
- Fama, Eugene F. and Kenneth R. French, 2010, "Luck versus Skill in the Cross-Section of Mutual Fund Returns" Journal of Finance 65, 1915-1947
- Berk, Jonathan, 2005" Five Myths of Active Portfolio Management," Journal of Portfolio Management, Vol. 31, pp. 27-31
- Youtube videos (now part 2) 8.x
Module 9. The Econometrics of Classic Linear Models
This week we'll study the econometrics of linear factor pricing models such as Fama and French.
This is really all a spacial case of GMM.
I prefer to have you see the application before the theory,
so, this is the econometric theory behind the Fama and French regressions
that you've already run, along with a lot of conceptual
review about what we're running and why.
- Asset Pricing Ch. 12. "Regression-Based Tests of Linear Factor Models;"
- Asset Pricing Ch. 15 "Time-Series, Cross-Section, and GMM/SDF Tests of Linear Factor Models;"
- Asset Pricing Ch. 16 "Which Method?"
- Youtube videos 9.x
Module 10. Time-Series Predictability, Volatility, and Bubbles
In this module, we'll study time series predictability in detail.
We looked at regressions of returns on dividend yields in Module 2, but now we'll look a lot deeper, including present values, identifying cashflow and discount rate shocks,
and tying predictability to volatility and so-called bubbles.
- Cochrane, John, 2011, "Discount Rates," Journal of Finance 66, 1047-1108 (August 2011). p. 1047-1058.
- Extensive notes. (63 pages). Written out treatment of predictability, suitable for reading on its own not just as a backdrop to the lecture.
- Asset Pricing Ch. 20.
- Lecture notes. A short version (19 pages) with the same material
and the main bullet points. My lecture notes.
- Youtube videos 10.x
Module 11. Equity Premium, Macroeconomics, and Asset Pricing
In this module, we'll study the connection between macroeconomics and asset pricing.
This is, really, I think a highlight of financial economics.
Just what are the fundamental, economic, risks that investors in asset markets seem so scared of,
that they allow large risk premiums to survive?
This is also an area that made huge progress, took a breath,
and is back in full force.
The experience of the 2008 financial crisis and recession says a lot about the kind of
event people are afraid of! A more detailed list of topics:
- Equity Premium and other puzzles
- Power utility tests, Utility function preview
- Recursive Utility/long-run risks
- Idiosyncratic risk, heterogeneous preferences
- Production and general equilibrium.
- Summary; other approaches
- Macro-Finance. I wrote this after the lecture,
really summing up everthing in this lecture. I survey many current frameworks including habits, long run risks, idiosyncratic risks, heterogenous preferences,
rare disasters, probability mistakes, and debt or institutional finance.
- Asset Pricing Ch1; Ch 21 "Equity Premium Puzzle and Consumption-Based Models"
- Cochrane, John H., 2011, Discount rates Journal of Finance 66, 1047-1108 Sectons III Theories, and Section IV Recent Performance.
- Cochrane, John H., 2007,
Financial Markets and the Real Economy in Rajnish Mehra, Ed. Handbook of the Equity Premium Elsevier 2007, Section 3. "Equity Premium," Section 4., "Consumption Models" and Section 5. "Production, Investment, and General Equilibrium". Don't miss the Appendix on Recursive Utility.
My lecture covered a lot of papers. Here are the original papers. They are not required reading for this class, as the lectures are self contained. But you do need to know just what the papers are you're learning about, and you should read these if you want to pursue the topic further.
- Main points covered in the lectures
- Campbell, John Y. and John H. Cochrane 1999, By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior Journal of Political Economy,107, 205-251. Manuscript with extra appendices
- Ravi Bansal, Dana Kiku and Amir Yaron, 2012 An Empirical Evaluation of the Long-Run Risks Model for Asset Prices Critical Finance Review, 2012, 1: 183-221
- Beeler, Jason and John Y. Campbell, 2012, The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment", Critical Finance Review: Vol. 1: No. 1, pp 141-182.
- Constantinides, George M. and Darrell Duffie, 1996, "Asset pricing with heterogeneous consumers." Journal of Political Economy 104 (1996): 219-240.
- Garleanu, Nicolae, and Stavros Panageas, 2014, "Young, Old, Conservative and Bold. The implications of finite lives and heterogeneity for Asset Pricing" Manuscript, forthcoming June 2015 Journal of Political Economy
- Cochrane, John H. 1991, Production-Based Asset Pricing and the Link Between Stock Returns and Economic Fluctuations The Journal of Finance 46, 209-237. This is the source of the graph and tables for the "Production" section.
- References for minor points
- Chen, Hui, Winston Dou and Leonid Kogan 2013, "Measuring the `Dark Matter' in Asset Pricing Models," Manuscript, Available from Chen's website.
This is the source of the "Dark Matter" quip from the lecture on recursive utility.
- Schmidt, Lawrence, 2015, "Climbing and Falling Off the Ladder: Asset Pricing Implications of Labor Market Event Risk", Manuscript.
A recent paper I mentioned in lecture that uses the Constantinides-Duffie mechanism, adding rare disasters to individual risks. (Many references will allow you to quickly move back and catch up with the current literature)
- Cochrane, John H., 2003, "Stock as Money: Convenience Yield and the Tech-Stock Bubble" in William C. Hunter, George G. Kaufman and Michael Pomerleano, Eds., Asset Price Bubbles Cambridge: MIT Press 2003. Alas, no pdf of the published version is available.
This is the source of the graph linking the level of prices to volatility.
- Jagannathan, Ravi, and Yong Wang, 2007, Lazy Investors, Discretionary Consumption, and the Cross-Section of Stock Returns The Journal of Finance, 62 (4) 1623-1661.
The consumption CAPM works quite well from December to December. This is the source of the graph shown in lecture and the problem set you solved a few weeks ago.
- Cochrane, John H., Notes on utility functions (lecture notes, a reference.)
- Note, I left out a lot! There is a whole resurgent interest in "rare disasters" that I have not covered. Plus, there is a lot of macro/asset pricing literature that is trying to put in various financial frictions at the core of both. Some of this is an attempt to understand the 2008 financial crisis, a worthy subject. The big question is whether such frictions are important for every day asset pricing.
- Youtube videos 11.x
Module 12. Option Pricing
In this module, we'll discuss option pricing, the Black-Scholes option-pricing formula,
and empirical option pricing. Of course I relate option and arbitrage pricing to p=E(mx), rather than
treat it as a separate idea.
Module 13. Bonds
In this module, we'll discuss bonds and models of the term structure
of interest rates.
- Required Reading
- Asset Pricing chapter 19.
- Asset Pricing chapter 20, pages 422-453.
- Optional Reading
- Cochrane, John H. and Monika Piazzesi, Bond Risk Premia Ignore section V “Tests.”
- Cochrane, John H. and Monika Piazzesi, Decomposing the Yield Curve.
- Lustig, Hanno, Nikolai L. Roussanov, and Adrien Verdelhan, 2011, Common Risk Factors in Currency Markets, Review of Financial Studies 24: 3731-3777. Read only through p. 3750.
- Lecture notes, part 1 and part 2.
- Youtube videos 13.x
Module 14. Portfolio Theory
In this module, we'll discuss portfolio theory in more detail.