This book offers a definitive and wide-ranging overview of developments in behavioral finance over the past ten years. In 1993, the first volume provided the standard reference to this new approach in finance--an approach that, as editor Richard Thaler put it, "entertains the possibility that some of the agents in the economy behave less than fully rationally some of the time." Much has changed since then. Not least, the bursting of the Internet bubble and the subsequent market decline further demonstrated that financial markets often fail to behave as they would if trading were truly dominated by the fully rational investors who populate financial theories. Behavioral finance has made an indelible mark on areas from asset pricing to individual investor behavior to corporate finance, and continues to see exciting empirical and theoretical advances. Advances in Behavioral Finance, Volume II constitutes the essential new resource in the field. It presents twenty recent papers by leading specialists that illustrate the abiding power of behavioral finance--of how specific departures from fully rational decision making by individual market agents can provide explanations of otherwise puzzling market phenomena. As with the first volume, it reaches beyond the world of finance to suggest, powerfully, the importance of pursuing behavioral approaches to other areas of economic life. The contributors are Brad M. Barber, Nicholas Barberis, Shlomo Benartzi, John Y. Campbell, Emil M. Dabora, Daniel Kent, Francois Degeorge, Kenneth A. Froot, J. B. Heaton, David Hirshleifer, Harrison Hong, Ming Huang, Narasimhan Jegadeesh, Josef Lakonishok, Owen A. Lamont, Roni Michaely, Terrance Odean, Jayendu Patel, Tano Santos, Andrei Shleifer, Robert J. Shiller, Jeremy C. Stein, Avanidhar Subrahmanyam, Richard H. Thaler, Sheridan Titman, Robert W. Vishny, Kent L. Womack, and Richard Zeckhauser. TABLE OF CONTENTS: Preface Richard H. Thaler Acknowledgments List of Abbreviations Chapter 1: A Survey of Behavioral Finance by Nicholas Barberis and Richard H. Thaler 1 Part I: Limits to Arbitrage Chapter 2: The Limits of Arbitrage by Andrei Shleifer and Robert W. Vishny Chapter 3: How Are Stock Prices Affected by the Location of Trade? by Kenneth A. Froot and Emil M. Dabora Chapter 4: Can the Market Add and Subtract? Mispricing in Tech Stock Carve-outs by Owen A. Lamont and Richard H. Thaler Part II: I Stock Returns and the Equity Premium Chapter 5: Valuation Ratios and the Long-run Stock Market Outlook: An Update by John Y. Campbell and Robert J. Shiller Chapter 6: Myopic Loss Aversion and the Equity Premium Puzzle by Shlomo Benartzi and Richard H. Thaler Chapter 7: Prospect Theory and Asset Prices by Nicholas Barberis, Ming Huang, and Tano Santos Part III: Empirical Studies of Overreaction and Underreaction Chapter 8: Contrarian Investment, Extrapolation, and Risk by Josef Lakonishok, Andrei Shleifer, and Robert W. Vishny Chapter 9: Evidence on the Characteristics of Cross-sectional Variation in Stock Returns by Kent Daniel and Sheridan Titman Chapter 10: Momentum by Narasimhan Jegadeesh and Sheridan Titman Chapter 11: Market Efficiency and Biases in Brokerage Recommendations by Roni Michaely and Kent L. Womack Part IV: Theories of Overreaction and Underreaction Chapter 12: A Model of Investor Sentiment by Nicholas Barberis, Andrei Shleifer, and Robert W. Vishny Chapter 13: Investor Psychology and Security Market Under- and Overreaction by Kent Daniel, David Hirshleifer, and Avanidhar Subrahmanyam Chapter 14: A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets by Harrison Hong and Jeremy C. Stein Part V: Investor Behavior Chapter 15: Individual Investors by Brad M. Barber and Terrance Odean Chapter 16: Naive Diversification Strategies in Defined Contribution Savings Plans by Shlomo Benartzi and Richard H. Thaler Part VI: Corporate Finance Chapter 17: Rational Capital Budgeting in an Irrational World by Jeremy C. Stein Chapter 18: Earnings Management to Exceed Thresholds by Francois Degeorge, Jayendu Patel, and Richard Zeckhauser Chapter 19: Managerial Optimism and Corporate Finance by J. B. Heaton List of Contributors Index