Chapter 18 A SURVEY OF BEHAVIORAL FINANCE* NICHOLAS BARBERIS University of Chicago RICHARD THALER University of Chicago Contents Abstract 1054 Keywords 1054 1.Introduction 1055 2.Limits to arbitrage 1056 2.1.Market efficiency 1056 2.2.Theory 1058 2.3.Evidence 1061 2.3.1.Twin shares 1061 2.3.2.Index inclusions 1063 2.3.3.Internet carve-outs 1064 3.Psychology 1065 3.1.Beliefs 1065 3.2.Preferences 1069 3.2.1.Prospect theory 1069 3.2.2.Ambiguity aversion 1074 4.Application:The aggregate stock market 1075 4.1.The equity premium puzzle 1078 4.1.1.Prospect theory 1079 4.1.2.Ambiguity aversion 1082 4.2.The volatility puzzle 1083 4.2.1.Beliefs 1084 4.2.2.Preferences 1086 5.Application:The cross-section of average returns 1087 5.1.Belief-based models 1092 We are very grateful to Markus Brunnermeier,George Constantinides,Kent Daniel,Milt Harris,Ming Huang.Owen Lamont,Jay Ritter,Andrei Shleifer,Jeremy Stein and Tuomo Vuolteenaho for extensive comments. Handbook of the Economics of Finance,Edited by G.M.Constantinides,M.Harris and R.Stulz 2003 Elsevier Science B.V.All rights reservedChapter 18 A SURVEY OF BEHAVIORAL FINANCE° NICHOLAS BARBERIS University of Chicago RICHARD THALER University of Chicago Contents Abstract 1054 Keywords 1054 1. Introduction 1055 2. Limits to arbitrage 1056 2.1. Market efficiency 1056 2.2. Theory 1058 2.3. Evidence 1061 2.3.1. Twin shares 1061 2.3.2. Index inclusions 1063 2.3.3. Internet carve-outs 1064 3. Psychology 1065 3.1. Beliefs 1065 3.2. Preferences 1069 3.2.1. Prospect theory 1069 3.2.2. Ambiguity aversion 1074 4. Application: The aggregate stock market 1075 4.1. The equity premium puzzle 1078 4.1.1. Prospect theory 1079 4.1.2. Ambiguity aversion 1082 4.2. The volatility puzzle 1083 4.2.1. Beliefs 1084 4.2.2. Preferences 1086 5. Application: The cross-section of average returns 1087 5.1. Belief-based models 1092 ° We are very grateful to Markus Brunnermeier, George Constantinides, Kent Daniel, Milt Harris, Ming Huang, Owen Lamont, Jay Ritter, Andrei Shleifer, Jeremy Stein and Tuomo Vuolteenaho for extensive comments. Handbook of the Economics of Finance, Edited by G.M. Constantinides, M. Harris and R. Stulz © 2003 Elsevier Science B.V. All rights reserved