Business 35150 Fall  2007                                                              

John H. Cochrane

 

Reading list

 

Do the required readings before class. The problems for each week will use some facts from that week's reading, and we will discuss readings in class.

 

Important copyright notice: PDF files are distributed for class use only. You may not redistribute them, post them on the web, etc.

 

All papers will be here on the website. The packet is optional, you can buy it if you don’t want to print everything out, but you won’t miss anything if you just get pdfs here.

 

Note: I may drop or add articles relative to the packet. The current version of this document on the class website is the official reading list.

 

The “questions” link won’t work until a week or two before class. I have to read the papers and come up with questions!

 

Most of the “not required” readings are full text versions of papers that I will mention in lecture. I’ll typically just show one table or picture. You’re not responsible for the whole paper. You are responsible for understanding the lecture discussions, table and/or picture. Other “not required” readings are further readings in some main topic areas, for your interest if you want to go deeper. They are not in the printed course packet.

 

Week 1. Returns are predictable over time.

   

  1. Notes  This includes an investments review. Skim to make sure you know this stuff and where to find it when you need it later. This week, pay special attention to Chapters 2 (probability and statistics review, regressions, and especially time series) and 5 (everything you need to know about matrices).
  2. Asset Pricing Ch. 20, introduction and 20.1 pp 389-401; 422-435. “Time series predictability.”

 

Not required.

 

  1. Boudoukh, Michaeli, Richardson and Roberts, 2006, “On the importance of measuring payout yield: implications for empirical asset pricing,” forthcoming Journal of Finance. Data are available on Michael Roberts’ webpage.
  2. Lettau, Martin and Sydney Ludvigson, 2001, “Consumption, Wealth, and Stock Returns,” Journal of Finance 55,  815-849. Via Library
  3. Cochrane, John H., “The dog that did not bark: A defense of return predictability’’ Forthcoming Review of Financial Studies

 

 

Week 2. The cross section of stock returns; from CAPM to value, size, momentum and anomalies

 

  1. Asset Pricing 20.2- End of Chapter 20. 435-453.
  2. Fama Eugene F. and Kenneth R. French 1996 "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance 51, 55-84. Skip section V, 68-75.
  3. Fama, Eugene F., and Kenneth R. French 2006, “Dissecting Anomalies” Manuscript, University of Chicago. All the new anomalies that have cropped up since value.

 

Not required

 

  1. Davis, James, Eugene F. Fama, and Kenneth R. French 2000, “Characteristics, Covariances, and Average Returns: 1929 to 1997” Journal of Finance 55 389-406. Our problem set suggests that the characteristics (size, b/m) are more powerful predictors of returns than the betas. There’s nothing wrong with that; betas are not perfectly measured. Still, is it true? Here’s FF’s view of the issue.
  1. Lee, C. M. C. and B. Swaminathan (2000). "Price Momentum and Trading Volume." Journal of Finance 55(5): 2017-2069. Stop reading at section E p.2038 I’ll summarize the main point, which you have to dig out of the tables: a twin sort on volume and momentum gives a bigger spread in average returns, but is pretty well explained by hml betas (we don’t need a new factor). I put it here because cross-sorts involving past volume are a big part of hedge fund models.
  2. Avramov, Doron, Tarun Chordia, Gergana Jostova and Alexander Philipov, 2007, “Momentum and Credit Rating” Manuscript. Momentum is primarily a phenomenon of low credit firms. I put it here as a “latest word on momentum” paper.

 

Week 3. Asset pricing theory and equity premium

 

  1. Utility, discount factors, expected returns   Asset Pricing  Ch 1 through 1.4 3-25.  35-45.
  2. Equity premium and macroeconomic risks.  Asset Pricing Ch. 21.1. 455-465

 

Week 4. Factor pricing models and empirical methods

 

  1. CAPM, ICAPM, APT and all that. (Asset Pricing Ch. 9 has a derivation, but I’m not assigning it. Lecture notes should be sufficient)
  2. Asset pricing empirical methods.   Time series regressions, cross sectional regressions, Fama MacBeth, Ch.12,  Ch. 13.4. 229-239; 243-251.  

 

Week 5.  Mutual funds

 

  1. Questions on mutual fund readings (be prepared to answer these in class!
  2. Carhart, Mark M., 1997, “On Persistence in Mutual Fund Performance,” Journal of Finance 52, 57-82. JSTOR link
  3. Davis, James, L., 2001, “Mutual Fund Performance and Manager Style” Financial Analysts Journal. 57, 19-27 Link through library
  4. Chen, Hsiu-Lang, Narasimhan Jegadeesh, and  Russ Wermers, 2000, “The Value of Active Mutual Fund Management: An Examination of the Stockholdings and Trades of Fund Managers” The Journal of Financial and Quantitative Analysis, Vol. 35, No. 3. (Sep., 2000), pp. 343-368.
  5. Carhart, Mark M., Ron Kaniel, David K. Musto and Adam V. Reed, 2002 “Leaning for the Tape: Evidence of Gaming Behavior in Equity Mutual Funds” Journal of Finance LVII (2) 661-691.
  6. Frazzini, Andrea, Lauren Cohen and Christopher Malloy, 2007 “The Small World of Investing: Board Connections and Mutual Fund Returns”    NBER Working paper 13121

 

Not required

  1. Kruger, Samuel A., 2007, “Persistence in Mutual Fund Performance: Analysis of Holdings Returns”, manuscript, University of Chicago. This was a student paper for Fama’s research class. Kruger replicates Carhart, extending data as we do, and using the returns on reported fund holdings rather than fund returns. This allows him to see if transactions costs and expenses really do account for Carhart’s bad alphas. They do.
  2. Marcin Kacperczyk, Clemens Sialm, Lu Zheng, 2005, “Unobserved Actions of Mutual Funds”, NBER  Working Paper 11766 Another paper exploiting the holdings data. This one looks at the difference between actual returns and the returns from holding the disclosed portfolio without further trading. Does the trading add anything?
  3. Judith Chevalier; Glenn Ellison , “Are Some Mutual Fund Managers Better than Others? Cross-Sectional Patterns in Behavior and Performance,” The Journal of Finance, Vol. 54, No. 3. (Jun., 1999), pp. 875-899. Link through JSTOR  Do managers with MBAs do better?
  4. Judith Chevalier; Glenn Ellison , “Risk Taking by Mutual Funds as a Response to Incentives,” The Journal of Political Economy, Vol. 105, No. 6. (Dec., 1997), pp. 1167-1200.  Link through JSTOR  This has the great graph I show in class, showing how good returns lead to more money
  5. Jonathan B. Berk and Richard C. Green, 2004 “Mutual fund flows and performance in rational markets” Journal of Political Economy 112, 1269-1295. This is a very nice economic model of the puzzling fact that funds with good past returns get more money. No, you don’t need irrational investors to generate the fact.
  6. Berk, Jonathan and Richard Stanton, “Managerial Ability, Compensation, and the closed-end fund discount” Journal of Finance 62, 529-556. Extends the argument to closed end funds.

 

 

Week 6.  Hedge funds

 

  1. Questions on hedge fund readings
  2. Mitchell, Mark and Todd Pulvino, 2001, “The characteristics of risk and return in risk arbitrage” Journal of Finance 56, 2135-2176  Link through library
  3. Malkiel, Burton, and Atanu Saha, 2005, “Hedge Funds: Risk and Return,” Financial Analysts Journal 61 (6) 80-89. Link through library
  4. Asness, Cifford, Robert Krail and John Liew, 2001, Do hedge funds hedge? Journal of Portfolio Management, 28 (Fall) 6-19.
  5. Agarwal, Vikas and Narayan Naik, 2004, “Risk and Portfolio Decisions Involving Hedge Funds” Review of Financial Studies. 17: 63 - 98.  Skip section 5.
  6. Adrian, Tobias, 2007, “Measuring Risk in the Hedge Fund Sector,’’ Current Issues, Federal Reserve Bank of New York, 13 (March/April 2007) Link to NY Fed
  7. What's it all about, alpha? Mar 22nd 2007 The Economist (Required, but not in print packet). This and the next reading introduce us to the idea of passive, investible, hedge-find style products.  
  8. Hasanhodzic, Jasmina and Andrew W. Lo, 2007, “Can Hedge-Fund Returns be Replicated?: The Linear Case” Journal of Investment Management 5(2) 5-45.

 

 

Not required

 

  1. Stulz, Rene, 2007, “Hedge Funds: Past, Present and Future,” Journal of Economic Perspectives 21(2) 175-194. This is a good overview. Read it. I only didn’t make it required because I don’t plan to discuss it page by page in class.
  2. Asness, Clifford, 2004, “An Alternative Future Part II: An Exploration of the Role of Hedge Funds.” Journal of Portfolio Management, Fall 2004, v. 31, iss. 1, pp. 8-23. Beautiful exposition of where funds are, where they’re going, and why they’re likely to stick around.
  3. Hasanhodzic, Jasmina, and Andrew W. Lo, 2006, “Attack of the clones”, Institutional Investor’s Alpha June 2006. This is the popularized version of the “real” one which is assigned above.
  4. Naik, Narayan Y., 2006, “Why is Santa so Kind to Hedge Funds?’’ Manuscript, London Business School. “Leaning for the tape” in hedge funds.

 

 

 

Week 7.  Liquidity, short sales constraints

 

  1. Questions on liquidity, shorts, etc.
  2. Lamont Owen, and Richard Thaler 2003, “Can the Market Add and Subtract?: Mispricing in Tech-Stock Carve-Outs” Journal of Political Economy 111: 227-268 Link through JPE online edition
  3. Cochrane, John H., “Stock as Money: Convenience Yield and the Tech-Stock Bubble” Manuscript. (Eventually published in William C. Hunter, George G. Kaufman and Michael Pomerleano, Eds., Asset Price Bubbles Cambridge: MIT Press 2003 ; NBER working paper 8987 )
  4. Lamont, Owen, (2004) “Go Down Fighting: Short Sellers vs. Firms” Manuscript, Yale University.
  5. Brandt Michael and Kenneth A. Kavajecz, 2004, “Price Discovery in the U.S. Treasury Market: The impact of Orderflow and Liquidity on the Yield Curve” Journal of Finance 59, (Dec) 2623-2654. Stop reading at section III p. 2644. (You may be interested in IV “common trading strategies” but I won’t cover it in class.) 
  6. Mitchell, Mark, Lasse Heje Pedersen, and Todd Pulvino, 2007, “Slow-Moving Capital” Manuscript

 

 

Not required:

 

  1. Mei, Jianping, José Scheinkman and Wei Xiong, 2005, “Speculative Trading and Stock Prices: Evidence from Chinese A-B Share Premia,” Manuscript, Princeton University. Link through Xiong’s website. This nice paper shows many of the points in “Stocks as money” hold in Chinese A-B shares. I’ll show the main tables in class.
  2. Lamont, Owen, and Jeremy C Stein, "Aggregate Short Interest and Market Valuations"  American Economic Review, May 2004. This shows a puzzle: short interest is not very high at peaks. Their view: shorts get wiped out on the way up. My view: few people who want to short the index do so by shorting individual stocks. Still, a good fact to know.
  3. Boehmer, Ekkeheart, Charles M. Jones and Xioyan Zhang, 2006, “Which Shorts are Informed?” Manuscript, Columbia University Link to Jones’ website The latest on short sales, and which category of investor’s short decisions are followed by poor returns. Interesting in that poor returns should follow a short constraint, i.e. unrequited desire to short. Poor returns should not follow a lot of shorting; the shorting should lower the price right away.
  4. Cohen, Lauren, Karl Diether and Christopher Malloy, 2006, “Supply and Demand Shifts in the Shorting Market” Forthcoming Journal of Finance. Link through Cohen’s website  This is a really nice analysis based on the short lending program of a big quasi-passive investment firm.
  5. Mitchell, Mark, Todd Pulvino and Erik Stafford, 2004, “Price Pressure Around Mergers” Journal of Finance, 59, 31-63. Stafford’s website Arbitrageurs move prices around merger announcements.
  1. Mitchell, Mark, Lasse Heje Pedersen, and Todd Pulvino, 2007, Slides for “Slow-Moving Capital”
  1. Cochrane, John, 2004, Liquidity, Trading and Asset Prices, NBER Reporter. This is a summary of what I know about liquidity and trading.

 

 

Week 8 Term structure I

 

a) Expectations hypothesis and its failures

  1. Asset Pricing Ch 19.1 19.1 is background and review reading. You need to remember yields, forward rates, expectations hypothesis, and duration. The Notes also have a quick review of this material.   Asset Pricing 20.1, “Bonds” and “Foreign Exchange”
  2. Cochrane, John H. and Monika Piazzesi, “Bond Risk Premia” American Economic Review March 2005. Ignore section V “Tests.”  Appendix to Bond Risk Premia, only read A.2-A.5, B.3
  3. Burnside, Craig, Martin Eichenbaum, Isaac Kleshchelski, and Sergio Rebelo, 2006, “The Returns to Currency Speculation” Manuscript, Northwestern University.  This is the best paper I could find with updated estimates of the exchange rate regressions.

 

Not required

  1. I don’t take BEIR’s “explanation” too seriously, see my  Comments on “The Returns to Currency Speculation”  if you’re curious. We’re going to focus only on their numbers, not their explanation in terms of transaction costs.
  2. Comments on ‘Macroeconomic Implications of Changes in the Term Premium’ My thoughts on the “Conundrum” and some deeper analysis of term structure than we’ll have time for in class.

 

 

 

Week 9 Term structure II

 

 b) Term structure models

  1. Eigenvalue factor decomposition – lecture notes.
  2. Asset Pricing 19.3 (If you know dz and dt, I encourage you to read 19.5. However, the class discussion will be limited to discrete time models in order to avoid continuous time mathematics.) 

 

Week 10. Portfolio theory.

 

  1. Cochrane, John H. 1999, “Portfolio Advice for a Multifactor World” Economic Perspectives Federal Reserve Bank of Chicago 23 (3) 59-78. #6156
  2. Review Notes Ch. 4 on maximization

 

Not required

 

1. Cochrane, John H., 2007, “Portfolio theory” draft of a new chapter for Asset Pricing

   

 

 

How to find additional academic papers. You must be connected to the GSB network or enable the proxy server mechanism on your own machine. I 1: go to the library catalog. 2. Use the “journal alphabetical” search to find the journal. 3. There will be an “electronic resource” link to the online issues. 4. Find the issue you want and download.