John Cochrane Spring 2015 Asset Pricing PhD Class (Stanford Edition)

Last update 5/23/2015

Update: June 1 class will be a writing workshop. If you have not received email, contact me.

Class structure

I will be teaching three weeks of this class, April 6, April 13, and June 1.

This class will be integrated with three weeks of my coursera online course. You must sign up for the coursera class Asset Pricing Part 2 (be careful not to sign up for part 1!). You do not need to get a "certificate." Just "join for free". Do this right away! If you have technical problems you can email the coursera TAs Adam Jorring (Chicago) or Nina Karnaukh (St. Gallen).

Send me an email at john.cochrane@chicagobooth.edu with your email, username or whatever other identifying information you give coursera so we can pick your results out from the others. There is a special discussion forum for you.

Each week, do the corresponding coursera work before class. That involves watching some video lectures and doing some quizzes and homeworks.

The point of doing coursera first is that it will free me from lecturing on standard material, and will free us up to have a more freewheeling class discussion. Come to class prepared to present and to discuss the material. It also will free us to talk about the more advanced readings given below.

All readings have links. Please report broken links. Some links are to jstor or sciencedirect, which want an institutional login or vpn connection. If they ask for money, that's the problem.

You need access to my book, Asset Pricing, Princeton University Press, Revised Edition. The old edition is full of typos, so I recommend the revised edition. It's available at

Amazon.com offers list price of $101.64, links to offers from other sellers around $50, Kindle for $84.00 and a 6 month kindle rental for $23. That's the cheapest option I can find.
Barnes and Noble offers similar prices. Again, the 6 month $23 rental is the obvious cheap option.
Princeton University Press sells the hardcover for $115. It has a link to the Preface and Chapter 1 which you can read for free. Princeton's ebook edition is $92 with a 6 month rental at $46 , not a great deal
Google it...

Week 1 (April 6) Characteristics and the cross section of returns.

Rrequired readings. Focus on the tables and facts.

Do coursera Part 2 week 1.
Fama and French, 1996, "Multifactor Explanations of Asset Pricing Anomalies", p. 55-84.
Skip section V, 68-75. This is the focus of the coursera lecture. We'll also review main points in class.
Fama and French, 2006, "Dissecting Anomalies."
An investigation of new anomalies that have cropped up since value. And a strong suspicion that many anomalies are only present in dusty corners of the market.
Cochrane, John, 2011, Discount rates Section II "Cross-Section" p. 1058-1063.
A Compact summary of where we are and where I think we are going. Thesis topic suggestions.

Optional. Additional review or textbook treatments (FYI, and some overlap)

Asset Pricing Chapter 20.2. My "textbook" treatments of the Fama French model and what it means.
Cochrane, John H., Financial Markets and the Real Economy p. 251-257. Section 1-2 A newer summary of the Fama French paper. And time-series forecastability.
Cochrane, John H., Lecture notes on value and Fama-French.
Cochrane, John H., New Anomalies
Lecture notes on "dissecting Anomalies," profitability premium, 5 factors, and betting against beta.

Reference readings. I'll show the main tables of these as a tour of what's going on in current research.

Fama and French, 2015, A five - factor asset pricing model Journal of Financial Economics 116, 1 ? 22.
The "profitability factor" and see FF struggling with lots of dimensions of expected returns.
Novy-Marx, Robert, 2013, The Other Side of Value: The Gross Profitability Premium, Journal of Financial Economics 108(1), 2013, 1-28. (Ungated draft)
Frazzini, Andrea, and Lasse H. Pedersen 2013 Betting against Beta Section II-IV only; focus on Table III and IV.
Skip the theory focus on the fact. We usually look for expected return spreads not explained by beta. but a beta spread not explained by expected returns is just as much of a puzzle!
(Link to paper on Pedersen's webpage. Pedersen's slides. Data set from AQR, a good replication / extension project.)
Cliff Asness, Lasse Pedersen, and Tobias Moskowitz, 2013, "Value and Momentum Everywhere," The Journal of Finance 68, 929 - 985, June 2013. Ungated at Moskowitz website .
Value and momentum exsit across asset classes and are negatively correlated. Is there one big value+momentum factor? Now you know AQR's latest strategy!
(Data for value and momentum portfolios)

Given time I will touch on this lightly beyond the coursera treatment. Jonathan will spend two weeks on it.

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
John H. Cochrane, Lecture notes, followed by written out notes on fund evaluation. The last page resolves, I think, the debate between Fama/French and Berk/VanBinsbergen.

Week 2. (April 9) Time-Series predictability, volatility, and bubbles.

Required Readings.

Do Coursera Part 2 Week 3 Predictability and Volatility before class. Do not do coursera week 2, econometrics of factor models.
Do Coursera week 6 videos through "facts: Fama Bliss." Just do the lectures and the Fama-Bliss homework.
Asset Pricing Ch. 20.1 p. 426-435
Cochrane, John H., 2011, Discount rates Journal of Finance 66, Section I, "Time Series Facts."

Reference readings. The papers covered in the lecture, and things I'll talk about these in class.

Eugene F. Fama, Robert R. Bliss, 1987, "The Information in Long-Maturity Forward Rates" The American Economic Review 77, 680-692
Cochrane, John H., and Monika Piazzesi, “ Bond Risk Premia” American Economic Review.
Ignore section V “Tests.” Bond risk premia is our update of the Fama-Bliss facts. There is a single-factor structure in expected returns.
Lustig, Hanno, Nikolai L. Roussanov, and Adrien Verdelhan, 2011, " Common Risk Factors in Currency Markets ," Review of Financial Studies24, 3731-3777.
Read only through p. 3750. Just see them apply the FF portfolio sort and factor model technique to fx. And wonder why it took 15 years to do it.
Lecture notes on stock predictability come in three flavors:
- slides as showin in the coursera lecture
- short notes (19 pages). Same material, bullet points for what I say in lecture.
- Fully written notes (60 pages), going a good deal beyond the lecture. A review paper someday?
Cochrane John H., Lecture notes on expectations hypothesis and Fama-Bliss regressions.

Week 3. (June 1) Equity Premium and macro/asset Pricing without financial frictions.

Required Readings. Our assigned readings will be summaries and reviews, all covered in the coursera lectures.

Do coursera Week 4, equity premium, macroeconomics and asset pricing.
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.
Asset Pricing Ch1; Ch 21 "Equity Premium Puzzle and Consumption-Based Models"

The underlying papers follow. I don't expect you to read every word! But I also don't want you to think I'm making up my characterization of these papers.

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. JSTOR link; 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 Ungated at Yaron's webpage
Jason Beeler 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.
Cochrane, John H., Notes on utility functions (12/2/2013)
Constantinides, George M. and Darrell Duffie "Asset pricing with heterogeneous consumers." Journal of Political Economy 104 (1996): 219?240.
Schmidt, Lawrence, 2015, "Climbing and Falling Off the Ladder: Asset Pricing Implications of Labor Market Event Risk"
In various reviews, I opined that the Constantinides-Duffie mechanism is not quantitatively large enough. This paper points out that much of the dispersion in income comes from job losses that may be rare big events and may overcome the quantitative problem. In any case the latest work in the C - D literature, and after my review in "financial markets and the real economy."
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
John H. Cochrane 1991, Production-Based Asset Pricing and the Link Between Stock Returns and Economic Fluctuations The Journal of Finance 46, 209-237. Ungated on my webpage
Cochrane, John H., " 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. The strong correlation of prices and trading activity is, to my mind, an under - appreciated fact which could be the basis of a lot of good papers.
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. Week 2 of coursera part 2 gives the data and guides you through a reconstruction if you're interested.
Two Trees (with Francis Longstaff and Pedro Santa-Clara), Review of Financial Studies 21 (1) 2008 347-385
An endowment economy with two iid trees produces interesting dynamics. It follows up on the idea that "we can't all rebalance." There's a thesis topic in adding adjustment costs to this model.
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.

Additional Readings

If you get interested in pursuing any of the topics, or if you're looking for an interesting replication or extension project, here is a list of papers I think are interesting in these literatures.

All of my asset pricing papers are on my research webpage. The "Grumpy economist finance collection may also be a useful source of topics.

Week 1 Additional Readings and References

Dissecting momentum. Warning, though attractive to dissect momentum, and though there is no really good answer, a lot of people are ahead of you.

Novy-Marx, RobertIs Momentum Really Momentum?, Journal of Financial Economics 103(3), 2012, 429-453. No, as sorting on the first six months of the year does better than sorting on the second six months of the year.
Kent Daniel, Ravi Jagannathan and Soohun Kim Tail Risk and Momentum Strategy Returns NBER Working paper 18169. Shows how momentum has infrequent huge losses. Data
Tobias J. Moskowitz, Yao Hua Ooi, Lasse Heje Pedersen, 2012, Time series momentum, Journal of financial economics Volume 104, Issue 2, May 2012, Pages 228?250 html at sciencedirect; DOI link. This paper very nicely ties together the "time series" approach of running forecasting regressions with the "cross section" approach of making portfolios. They are the same thing! But time and portfolio dummies matter.
Avramov, Doron, Tarun Chordia, Gergana Jostova and Alexander Philipov, 2007, "Momentum and Credit Rating" Manuscript. Momentum is primarily a phenomenon of low credit firms. Another "latest word on momentum" paper, showing how people are interacting momentum with other variables to better forecast returns
Narasimhan Jegadeesh and Sheridan Titman 2011, Momentum, Annual Review of Financial Economics Vol. 3: 493-509 ( DOI: 10.1146/annurev-financial-102710-144850. A good, recent readable review of momentum. However, they forget that momentum is a factor not just a feature of indvidual returns.
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 many hedge fund models.

Additional or review papers on size, value, momentum

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.
Fama, Eugene F. and Kenneth R. French 2011 Size, Value and Momentum in International Stock Returns, Journal of Financial Economics 105 (2012) 457?472. Always read the latest Fama French paper on anything.

Additional Variables that forecast stock returns

Week 2 Additional Readings and References

Additional References

Cochrane, John H. and Monika Piazzesi, Decomposing the Yield Curve. putting predictability in an affine model. The factor structure of expected returns. The term structure of risk premia. Needs revising/extending to the zero boudn period.
Appendix to “Bond Risk Premia,” which you should know about if you workn on this
Cochrane, John H., 2008, "The dog that did not bark: A defense of return predictability "Review of Financial Studies 21 (4) 1533-1575. My last word on the statistical controversies, and where I learned to decompose the identity to regression coefficients and errors.
Sean D. Campbell, Morris A. Davis, Joshua Gallin, Robert F. Martin, (2009) What moves housing markets: A variance decomposition of the rent ? price ratio Journal of Urban Economics 66, 90 ? 102. I didn't know about this when I wrote "Discount Rates" but they do the price volatility regression for houses much better than I did.
The Dog that Did Not Bark: A Defense of Return Predictability Review of Financial Studies21(4) 2008 1533-1575.
How you can't just test returns alone.
“ Volatility Tests and Efficient Markets: A Review Essay” Journal of Monetary Economics 27 (May 1991) 463-485.
How volatility tests are the same as return regressions
" Permanent and Transitory Components of GNP and Stock Prices" Quarterly Journal of Economics CIX (February 1994) 241-266

John Campbell Classics: The linearized present value relation, and some of his contributions to the stock predictability literature. These are important references for my lectures and notes on predictability

Campbell, John Y. and Robert J. Shiller, "Cointegration and Tests of Present Value Models" Journal of Political Economy 95, 1062-1088, October 1987.
Campbell, John Y., and Robert J. Shiller, "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors", Review of Financial Studies 1:195â?"228, Fall 1988.
Campbell, John Y., and John Ammer, "What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns", Journal of Finance 48:3â?"37, March 1993.

If you want to work on predictability, you need to catch up with Martin Lettau and Sydney Ludvigson's cay work. Start at Martin Lettau's Website. There are far more John Campbell papers than I have included here. Browse John Campbell's website.

Some high-frequency time-series return forcasters:

Tim Bollerslev, James Marrone, Lai Xu and Hao Zhou, 2011, "Stock Return Predictability and Variance RiskPremia: Statistical Inference and International Evidence" Skip right to table 4 and 5. They claim that the difference between realized and implied volatility can forecast stock returns, at short horizons. This is an example of the higher-frequency forecast variables that many hedge funds are using.
Stefan Nagel, 2011, "Evaporating Liquidity" ( "Evaporating Liquidity" This one documents short-term reversal strategies, how they are "liquidity provision" strategies and highly correlated with volatility forecasts..

A longer reading list on empirical finance organized by topics. May be helpful for any thesis work.