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Asset Pricing [Hardcover]

John H. Cochrane
4.5 out of 5 stars  See all reviews (2 customer reviews)
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Book Description

23 Jan 2005

Winner of the prestigious Paul A. Samuelson Award for scholarly writing on lifelong financial security, John Cochrane's Asset Pricing now appears in a revised edition that unifies and brings the science of asset pricing up to date for advanced students and professionals. Cochrane traces the pricing of all assets back to a single idea--price equals expected discounted payoff--that captures the macro-economic risks underlying each security's value. By using a single, stochastic discount factor rather than a separate set of tricks for each asset class, Cochrane builds a unified account of modern asset pricing. He presents applications to stocks, bonds, and options. Each model--consumption based, CAPM, multifactor, term structure, and option pricing--is derived as a different specification of the discounted factor.

The discount factor framework also leads to a state-space geometry for mean-variance frontiers and asset pricing models. It puts payoffs in different states of nature on the axes rather than mean and variance of return, leading to a new and conveniently linear geometrical representation of asset pricing ideas.

Cochrane approaches empirical work with the Generalized Method of Moments, which studies sample average prices and discounted payoffs to determine whether price does equal expected discounted payoff. He translates between the discount factor, GMM, and state-space language and the beta, mean-variance, and regression language common in empirical work and earlier theory.

The book also includes a review of recent empirical work on return predictability, value and other puzzles in the cross section, and equity premium puzzles and their resolution. Written to be a summary for academics and professionals as well as a textbook, this book condenses and advances recent scholarship in financial economics.


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Product details

  • Hardcover: 560 pages
  • Publisher: Princeton University Press; Revised edition (23 Jan 2005)
  • Language: English
  • ISBN-10: 0691121370
  • ISBN-13: 978-0691121376
  • Product Dimensions: 23.4 x 16.6 x 4 cm
  • Average Customer Review: 4.5 out of 5 stars  See all reviews (2 customer reviews)
  • Amazon Bestsellers Rank: 169,389 in Books (See Top 100 in Books)
  • See Complete Table of Contents

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Review

Co-Winner of the 2001 Paul A. Samuelson award

"This is a brilliant and useful book, well-deserving of the TIAA-CREF Samuelson Award. . . . The clever intuition and informal writing style make it a joy to read. Like a star athlete does with the sport, Cochrane makes it look easier than it really is."--Journal of Economic Literature

From the Inside Flap

"An excellent survey of asset pricing theory and applications from the modern viewpoint of stochastic discount factors and their associated geometry. This book was already a classic among finance scholars and on Ph.D. syllabi when it circulated in the form of class notes. It will also prove highly useful to practitioners who seek an in-depth introduction to these tools."--Yacine At-Sahalia, Princeton University

"This is a beautiful book that uses the elegant simplicity of the stochastic discount factor to present a general theory of the pricing of stocks, bonds, and derivatives and a practical approach to estimating particular models derived from the general theory. It will help experts in the field to consolidate their knowledge and beginners to appreciate the unity of asset pricing theory. Cochrane uses his mastery of the subject to present it in a clear and compelling manner that is easily accessible."--Michael Brennan, Anderson School, University of California, Los Angeles

"This is an impressive treatise of very high quality. It is a serious scholarly monograph, of interest to those who are working to advance financial theory, and it can also serve as a textbook in an advanced finance course. It is thoughtful, inductive, and comprehensive."--Robert J. Shiller, author of Irrational Exuberance

"This is a sparkling, intuitive, makes-it-look-easier-than-it really-is, gem of a book . . . Cochrane's focus is the classical asset pricing models of frictionless markets and rational expectations. But the lessons learned are relevant in many empirical contexts. Cochrane's clever intuition and easy, informal writing style make the book a joy to read."--Wayne Ferson, Boston College

"This book represents an exciting step forward in the exposition of financial economics. The last twenty years of finance research have advanced and enriched the field, and textbook treatments have lagged behind these developments. This text will replace the previous generation of books and should have a broad market. It is written in an informal, almost breezy style that will appeal to students and is divided into small, easily digested chapters. . . . The book moves easily between discrete-time and continuous-time models. This is an excellent thing as it encourages students to see beyond the formalism to the underlying economics. I strongly recommend it as an advanced finance text."--John Y. Campbell, coauthor of The Econometrics of Financial Markets


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15 of 15 people found the following review helpful
4.0 out of 5 stars Nice book, shame it is written backwards! 23 Aug 2001
By A Customer
Format:Hardcover
The author presents a survey of the asset pricing literature from the 'unifying' stochastic discount factor framework. This is a refreshing attempt to unify the often ad-hoc approaches to asset pricing theory found in the literature. However, the book is structured in a manner that requires the reader to be already fully conversant in the literature. If they are not, many mysterious results are introduced in an apparently random nature, which only fit into the jigsaw puzzle some 50 pages later. I hope the second edition manages to address this problem by altering the structure. Otherwise, a pretty good stab at cleaning up the 'mess' left by the earlier asset pricing literature.
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2 of 4 people found the following review helpful
5.0 out of 5 stars very difficult book 17 Nov 2010
Format:Hardcover
this is a quite difficult book on asset pricing. limited illustration. but a very nice book after all. definitely sth to put on the bookshelf to look like a smart financial professional.
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Amazon.com: 3.7 out of 5 stars  40 reviews
47 of 49 people found the following review helpful
5.0 out of 5 stars The Practitioner's Portable Ph.D. 17 Nov 2005
By Craig W. French - Published on Amazon.com
Format:Hardcover|Verified Purchase
Given the innumerable finance books available, I find myself constantly trying to separate the wheat from the chaff (and, sadly, finding a whole lot more of the latter than the former). John Cochrane's Asset Pricing (2001, Princeton University Press) is not only wheat, but also perhaps the most finely milled flour baked to perfection into one's favorite dessert, served with a chilled glass of Château d'Yquem. Cochrane identifies his target audience as "economics and finance Ph.D. students, advanced MBA students, or professionals with similar background". Residing in the third camp, I can say from this point of view that this book could have been subtitled, "the Practitioner's Portable Ph.D." Academic researchers, students, and practitioners of finance should all value Cochrane's Asset Pricing enough to own a copy.

Asset Pricing is extremely readable, as Cochrane stresses economic intuition over formal proofs. The book is structured into four parts: 1) asset pricing theory; 2) asset pricing models; 3) options and interest rates; 4) an empirical survey. Cochrane begins powerfully, introducing us to the notion that the consumption-based asset pricing equation, given by an investor's first-order conditions, is the central formulation in asset pricing; market-based models simply consider the market returns specified in the consumption models to be exogenously determined free parameters. Cochrane emphasizes that all factor models are derived as specializations of the consumption-based model, using extra variables to proxy marginal utility.

In Part 1, Cochrane covers the field from the Law of One Price, to the mean-variance frontier, to the CCAPM, the CAPM, ICAPM and APT, covering both discrete- and continuous-time, as well as market- and consumption-oriented approaches. Cochrane begins with a simple concept: that price equals discounted payoff, and claims that this is the core of all asset pricing theory. I found this section to neatly clarify my understanding and perspective of these models. Cochrane argues effectively for the use of contingent-claims budget constraints as our lens rather than the traditional mean-variance frontiers and beta models: "...it has seemed that there are several different asset pricing theories: expected return-beta for stocks, yield-curve models for bonds, arbitrage models for options. In fact all three are just cases of p = E(mx)." Cochrane makes clear in his theorems of chapter 4 that the Law of One Price guarantees the existence of a discount factor, and the lack of pure arbitrage implies that the discount factor must be positive. Furthermore, the absence of arbitrage is the result of a positive discount factor, which is the natural result of any sort of utility maximization. Cochrane provides proofs of these relationships for both complete and incomplete markets. I also learned something new (to me) in Chapter 8: in addition to the famous Roll (1977) critique, which states that testing the CAPM using empirical data is impossible because the wealth portfolio is not observable, there is another basic but profound critique due to Hansen and Richard (1987), regarding the conditional versus unconditional CAPMs, which asserts that tests of the CAPM are doomed since the conditioning information of the agents is not observable.

Part 2 introduces us to The Generalized Method of Moments (GMM) approach to free parameter selection, distribution estimation, and model evaluation. GMM is quite powerful and is becoming increasingly popular in empirical studies; one recent example of applied GMM can be found in Andrew Lo's 2002 paper "The Statistics of Sharpe Ratios" (FAJ 58(4)). Cochrane provides the background and methodology for implementing the GMM approach of Hansen and Singleton (1982). Cochrane also covers time-series and cross-sectional (OLS and GLS) regressions for testing linear factor models, with a special emphasis on the Fama-MacBeth (1973) procedure, as well as Maximum Likelihood, which is a special case of GMM, and closes the section with examples of Monte Carlo and bootstrap simulations. Chapter 16, "Which Method?", highlights both Cochrane's pragmatism and masterful intuition of the subject (which is evident throughout the book); I especially enjoyed his brief commentary on statistical philosophy here.

In Part 3, Cochrane covers option pricing and term structure of interest rate models. Two chapters (17 and 18) is hardly enough to do justice to options pricing, which is better served by a complete text such as Cox and Rubinstein's "Options Markets" or Hull's "Options, Futures, and Other Derivatives", but given the limited space, Cochrane does an impressive job, using the Law of One Price to describe put-call parity, arbitrage bounds, early exercise rules for American options, and the Black-Scholes and Feynman-Kac solutions as well as real options. Chapter 19 is devoted to bond pricing. Cochrane covers bond basics, yield curves, and term structure models. The Cox-Ingersoll-Ross (1985) model and the Vasicek (1977) models are shown to be special cases of the affine class of term structure models, and Cochrane derives all three. He also provides a nice review of the literature of both affine and non-affine models, including as Constantinides' 1992 closed-form solution and many others.

Part 4 provides a well-written survey of the empirical work in the field, specifically on time-series predictability, cross-sectional models and equity premium puzzles, and new variations on the consumption-based models. Cochrane also provides an introduction to continuous-time stochastic processes in the Appendix, which succinctly covers Brownian motion, time-series diffusions and Ito's lemma. Most chapters include several problems at the end, a nice addition for readers who really want to dig in and explore asset pricing directly. Although solutions are not provided in the book, Cochrane's website,

[...]

offers them via e-mail to teachers using Asset Pricing as a class text. The website also offers a preview of the book through page 50, which encompasses the Contents, Preface, and chapters 1 and 2 in their entirety. The website also contains an important errata page describing more than 160 equation typos and errors, additions and clarifications to the manuscript.

Cochrane's experience as editor of the Journal of Political Economy shines through in his clear writing style, and his students at Chicago's GSB, where he is Theodore O. Yntema Professor of Finance, are lucky indeed if this book is any indication of his teaching ability. Asset Pricing is not a book to be missed.
36 of 40 people found the following review helpful
2.0 out of 5 stars I wanted to love this book 10 July 2007
By Giuseppe A. Paleologo - Published on Amazon.com
Format:Hardcover|Verified Purchase
It's probably true that the first book you study about a subject inevitably determines your approach to it afterwards. My first book on asset pricing was Duffie's Dynamic Asset Pricing Theory (2nd ed), and it has perhaps forever biased my judgment. Given this caveat, I wanted to like this book. For econometricians, the stochastic discount approach is increasingly important, and Cochrane's articles are engaging and well written. But, no matter what the blurbs on the back cover of the book say, or what some Amazon reviewers claim, this is a flawed book. It's true that "the hurdles of asset pricing are really conceptual rather than mathematical" (last sentence in the book preface), but this is no excuse for being sloppy, and sloppiness in this book abounds. Assumptions are not clear; theorems are imprecisely stated. Continuous-time formulations pop up without explanation of the variables or of the motivation behind them. Expected-utility derivations are the main tool used by the author, but the connection between no-arbitrage, utility maximization and equilibrium are not clear, and one is led to think that the stochastic discount is unique to this line of reasoning. On the positive side, there are many interesting results and many intuitive explanations. My recommendation: i) read Duffie or Pliska first; ii) take the plunge and download Hansen & Richard's 1987 Econometrica paper (very dense); iii) read Cochrane, but reobtain all the results independently from what you have learned in in i) and ii).
18 of 21 people found the following review helpful
3.0 out of 5 stars Modern finance in a book finally 3 Feb 2002
By A Customer - Published on Amazon.com
Format:Hardcover
This book presents finance in the modern way: p=E(mx). After having read it, the reader should be able to understand the papers currently published in the field. That's the big advantage of the book, because, in this sense, it is better than Duffie's, Dothan's or Ingersoll's. Be advised that the book is not worried about technicallities or math, but the economics underlying the models in it.
However some deep discussions assumes the reader knows: mean-variance frontier, (C)CAPM, APT, and so on, including the several empirical tests already performed on these models and their results. This is not always true, and the reader can easily get lost.
The author uses graphs to clarify the ideas. It is not always successful. Many graphs are confusing. For instance, the author assumes the reader knows how to add and to subtract vectors graphically, which is really easy if you knew that in advance, but difficult to figure out if you do not.
Also there are several minor mistakes the reader should take care of. I am sure the second edition of the book will correct those mistakes and will make the book a lot better.
I think the part talking about the GMM econometrics very clear and that helps a lot to implement the models presented in it.
I recommend the book, mainly because there is no other book treating modern finance like that. Once you get used to it, you'll see the book is not difficult and very useful.
7 of 8 people found the following review helpful
5.0 out of 5 stars Leading edge finance - not for wimps! 25 Mar 2006
By therosen - Published on Amazon.com
Format:Hardcover
Cochrane provides a detailed text at the leading edge of Finance. It is written in an informal manner from one who loves Finance, to others who love Finance. As such, it is not an introduction to the field or "Pop Finance for Dummies". That said, it can bring one with a strong background in math and moderate background in Finance to the leading empirical edge of Asset Pricing. Although written in a light manner, each chapter requires several readings to understand. Definitely not for wimps!
26 of 35 people found the following review helpful
2.0 out of 5 stars OK depending on who you are 1 Feb 2002
By "ellitotc" - Published on Amazon.com
Format:Hardcover
Not of much use to the professional finance person.
Should put out free erata with book.
Liked APT treatment.
Fine for very theoretical readers,
who are already familiar with material.
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