Finance and the Behavioral Prospect
Risk, Exuberance, and Abnormal Markets

Authors: James Ming Chen



Explains how investor behavior affects financial economicsTraces market momentum, irrational exuberance, and speculative bubbles to cognitive biases

Reconciles mathematical finance with abnormal markets and irrational investors

This book explains how investor behavior, from mental accounting to the combustible interplay of hope and fear, affects financial economics. The transformation of portfolio theory begins with the identification of anomalies. Gaps in perception and behavioral departures from rationality spur momentum, irrational exuberance, and speculative bubbles. Behavioral accounting undermines the rational premises of mathematical finance. Assets and portfolios are imbued with “affect.” Positive and negative emotions warp investment decisions. Whether hedging against intertemporal changes in their ability to bear risk or climbing a psychological hierarchy of needs, investors arrange their portfolios and financial affairs according to emotions and perceptions. Risk aversion and life-cycle theories of consumption provide possible solutions to the equity premium puzzle, an iconic financial mystery. Prospect theory has questioned the cogency of the efficient capital markets hypothesis. Behavioral portfolio theory arises from a psychological account of security, potential, and aspiration.

Table of contents

Front Matter

The Structure of a Behavioral Revolution

Mental Accounting, Emotional Hierarchies, and Behavioral Heuristics

Higher-Moment Capital Asset Pricing and Its Behavioral Implications

Tracking the Low-Volatility Anomaly Across Behavioral Space

The Intertemporal Capital Asset Pricing Model: Hedging Investment Risk Across Time

Risk Aversion

The Equity Risk Premium and the Equity Premium Puzzle

Prospect Theory

Specific Applications of Prospect Theory to Behavioral Finance

Beyond Hope and Fear:Behavioral Portfolio Theory

Behavioral Gaps Between Hypothetical Investment Returns and Actual Investor Returns

Irrational Exuberance: Momentum Crashes and Speculative Bubbles

The Monster and the Sleeping Queen

Back Matter

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