Asset Pricing

I have read most PhD-level textbooks on finance and Cochrane's is my favorite. Cochrane gives you the intuition using graphs as well as mathematical proofs for most of the results. The book is oriented toward training financial economists rather than financial mathematicians. If you are a financial economist and need to buy ONE book on asset pricing theory, buy Cochrane (the REVISED edition). If you are a financial mathematician and need to buy ONE book on asset pricing theory, buy Duffie. If you are smarter than the two guys I am talking about who want to buy ONE book only, then buy both! They are both helpful.

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!

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 us

I have read the manuscripts of this book. The approach is a unified one for all asset pricing. While the method is sophisticated, the author presented it in a very easy-to-understand way with detailed explanation on the derivation of the equations. Highly recommended for those who like to know more about up-to-date method of asset pricing. It will also help those who specialise in macroeconomics.