Faculty
Professor Kenneth R. French
Objectives
Course Overview and Objectives
My overall goal is to help you develop a way of thinking about and framing investment decisions. We will explore portfolio theory, models of security returns (including the capital asset pricing model and the arbitrage pricing theory), the empirical behavior of security prices, market efficiency, performance evaluation, and behavioral finance. Although much of the course will focus on what I perceive to be the practical applications of these topics, we will also step back to see how the topics fit in a more general (or what you might perceive to be theoretical) framework.
Please note, this is not a course on security analysis or stock picking.
The required text is the eighth edition of Bodie, Kane and Marcus, Investments. There is also a digital course packet in the class folder with additional readings.
Requirements
Study Groups
The assignments, cases, and project for this course are intended to be collaborative efforts done in study groups. We will use a two step process to form groups. First, you have the opportunity to form a group of four or five students. If you do, please send my assistant, Rick Rielly (Richard.W.Rielly@Tuck.Dartmouth.Edu), an email identifying the members of the group by 12:00 PM Friday, September 18. He will then assign all remaining students to groups. To keep things simple, his allocations will be final. If you forget to tell him about your group by noon on Friday (or he just doesn’t see the email describing your group), that group does not exist. You can include students from both sections when forming a group.
Class Preparation and Participation
Please read the assignments and do the applications exercises before class. Your ability to participate in and learn from the class discussion is directly related to the amount you have prepared. Students who are not prepared spend their time trying to grasp the individual concepts, rather than focusing on how these concepts fit into a unifying framework.
I strongly encourage you to prepare for class in study groups. Group preparation helps clarify basic issues and provides a forum to test your ideas and arguments. A good guideline for class preparation is to assume that I will ask you (or your group) to explain the readings or applications exercise at the beginning of class.
Since the course emphasizes discussions and outside speakers, I expect students to attend all classes. If extraordinary circumstances prevent you from attending, please email me before class.
Materials
Plagiarism
Some of the material in this course has been used before. When preparing homework exercises or answering specific questions for class discussion, you should not consult with students from prior years, their class notes, or any other material that was made available to them. Any such consultation constitutes plagiarism and violates the norms of acceptable conduct in this course.
Laptop Policy
Laptops should be used in class only for class activities such as taking notes. They should not be used to check email, surf the web, or to do other non-class activities during class time.
Grading
Written Work and Grading
There are five applications exercises. You will earn two points for each exercise you hand in on time. Please prepare these assignments with your study group. Each group should hand in only one set of answers. Each group member is expected to make a significant contribution to the solution of every problem. This does not mean that everyone’s ideas must be included. It means that everyone should contribute about equally to the overall process.
You are also graded on class participation, worth a maximum of ten points. Your grade is based on my assessment of your contribution to classroom discussions. I focus more on the quality than the quantity of your contributions; many high quality comments are better than a few, but a few high quality comments are much better than many low quality comments. In fact, silence is better than many low quality comments. Other actions that impose costs on your colleagues, such as arriving late for class, also have an adverse effect on your grade.
Fifty percent of your grade is determined by an in-class midterm exam, which will be given during the class on November 3. The exam is closed-book and closed-notes, but you may use one 8˝ x 11 sheet of notes. Unlike the written assignments, you may not work on the exam in groups. If an emergency or illness forces you to miss the exam, you must contact me before the exam.
The remaining thirty percent of your grade is determined by a group project. Please work on this project with the other members of your study group. You may choose a topic from the following list or something else you are interested in. The write-up should be between five and ten pages. Please send Rick Rielly an email by 5:00 PM, September 25 describing the topic you have chosen. Projects are due in Bill Martin’s office (003 Chase) by 5:00 PM, November 12. I will ask a few groups who have prepared particularly interesting projects to make in-class presentations on November 16 and 17.
Possible topics:
1. Evaluate the way Morningstar adjusts for risk when rating mutual funds. Does the process make sense? Could the risk adjustments induce fund managers to distort their investment strategies? Are there better ways to control for risk?
2. Review and evaluate the evidence on trading strategies in sports betting. Many academics have examined the efficiency of the sports betting market. What do they find? If there are violations of market efficiency, are they consistent with possible violations observed in securities markets? Are they consistent with standard theories from behavioral finance?
3. Replicate an empirical study examining some aspect of financial markets. How do your results differ from the author’s? Why? What happens when you extend the sample period? What important decisions did the author make that are not described in the paper? You should not plunge in here unless you are computer savvy. Groups working on a replication cannot have more than three students. Also, check with me about the paper you plan to replicate before you start.
4. Examine the historical performance of a specific trading strategy. My evaluation of this project will not depend on the strategy’s performance, but rather on your analysis of why it might work (what you expected before you looked) and why it does or does not work. Again, this is a project for people who are computer savvy.
5. Review and evaluate the evidence about an alleged speculative bubble. Some people claim there have been many speculative bubbles in financial markets during the last three centuries. Purported bubbles include the Dutch tulip mania of 1634-1637, the Mississippi and South Sea bubbles of 1719-1720, and the Japanese stock price bubble of the 1980’s. Examine the evidence about an alleged bubble. Why does it look like a bubble after the fact? Could you have identified the price pattern in real time? Did some people identify the bubble in real time? Were they able to profit from their insight? You may study any reasonably suspicious incident except the recent alleged internet bubble, which we will look at in class. Please check with me, however, about the bubble you plan to explore.
6. Design a lifetime investment plan for a "typical" member of your group. I am looking for specific conclusions – such as how the investor’s portfolio will be allocated across different investment classes, what investment style (active, passive, mixed) he or she will use, and how the portfolio will change as the investor goes through life. One way to focus the project is to compare lifetime plans for an American student who will reside in the U.S. and a foreign student who will return to his or her homeland soon after graduation. How do the different savings, investment, and consumption opportunities available in the two countries affect the two strategies?
Both Bill Martin, the teaching fellow for the course, and I are available to provide guidance on the projects. Bill can be reached at William.C.Martin@Dartmouth.Edu. His office is 003 Chase and his phone number is 646-4021.
Review Session
Bill Martin will hold review sessions on Tuesdays, from 12:00 to 1:00. I will hold a review session in Shapiro at 7:00 P.M. on November 2. You are under no obligation to attend these sessions. Bill and I will not present new material; we will simply respond to any questions that are raised.
Schedule
9/14 1
Course Overview
Review BKM Chpts 1-5
Mahoney, "Manager-investor conflicts in mutual funds", Journal of Economic Perspectives, Spring 2004.
Dimensional Fund Advisors Case
9/15 2
Equilibrium Markets: The Efficient Amount of Inefficiency
BKM Chpt 11
Fama and French, "Luck versus Skill in the Cross Section of Mutual Fund á Estimates", August 2009. (There is a summary of this paper on our web site, FamaFrench.Com.)
Malkiel and Saha, "Hedge funds: Risk and return", Financial Analysts Journal, November/December 2005.
McGough and Siconolfi, "Buy and Fold: Their money’s fleeing but some investors just keep hanging on", Wall Street Journal, June 18, 1997.
9/21 3
The Cost of Active Investing
French, "The cost of active investing", working paper, 2008.
Sharpe, "The arithmetic of active management", Financial Analysts Journal, January/February 1991.
9/22 4
The CAPM and the Cross-Section of Expected Returns
Review BKM Chpts 9 and 10
BKM Chpt 13 pp. 410-432
Fama and French, "The Capital Asset Pricing Model: Theory and Evidence", Journal of Economic Perspectives, August 2004.
Applications Exercise 1 – Due Today
9/28 5
Guest Speaker: David Booth
CEO, Dimensional Fund Advisors
9/29 6
Factor Models of Stock Returns
Sharpe, "Factor models, CAPMs, and the APT", Journal of Portfolio Management, 1984.
Fama, French, Sinquefield, and Booth, "Differences in the risks and returns to NYSE and NASD stocks", Financial Analysts Journal, 1993.
10/5 7
Performance Evaluation
BKM Chpt 24
Sharpe, "Asset allocation: Management style and performance measurement", Journal of Portfolio Management, Winter 1992.
Applications Exercise 2 – Due Today
10/6 8
The Limits of Arbitrage
Fama and French, "Disagreement, tastes, and asset pricing", Journal of Financial Economics, 2007.
Shiller, "From efficient markets theory to behavioral finance", Journal of Economic Perspectives, Winter 2003.
Rashes, "Massively confused investors making conspicuously ignorant choices (MCI-MCIC)", Journal of Finance, October 2001.
10/12 9
Guest Speaker: Kent Daniel
Co-CIO and Director of Equity Research for Quantitative Investment Strategies, Goldman Sachs Asset Management
10/13 10
The Financial Crisis
Duffie, "The failure mechanics of dealer banks", June 2009.
10/26 11
Tax Efficient Investing
Reichenstein, "After-tax asset allocation", Financial Analysts Journal, July 2006.
Jeffrey and Arnott, "Is your alpha big enough to cover its taxes?", Journal of Portfolio Management, Spring 1993.
Arnott, Berkin, and Ye, "How well have taxable investors been served in the 1980s and 1990s?", Journal of Portfolio Management, Summer 2000.
10/27 12
Managing Portfolios
BKM Chpt 28 (Skim)
Kritzman, "What practitioners need to know about time diversification", Financial Analysts Journal, 1994.
Applications Exercise 3 – Due Today
11/2 13
Class cancelled
11/3 14
Midterm Exam
In class, closed book
Exam
11/09 15
Guest Speaker: Jeff Coyle
Managing partner, Waterline Partners
11/10 16
Estimating the Market Risk Premium
BKM Chpt 13 pp. 434-441
Siegel, "Perspectives on the equity risk premium", Financial Analysts Journal", November 2005.
Applications Exercise 4 – Due Today
11/12
Projects are due in Bill Martin’s office by 5:00 PM today, November 10.
11/16 17
Behavioral Finance
Kahneman and Tversky, "The psychology of preferences", Scientific American, 1982.
Shiller, "Human behavior and the efficiency of the financial system", Handbook of Macroeconomics, 1999.
11/17 18
Student Presentations, Course Review and Consolidation
