Review of John Cochrane's 'Asset Pricing'

Abstract

John Cochrane's Asset Pricing (2001, Princeton University Press) is targeted at 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 Asset Pricing 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. The book is extremely readable, as Cochrane stresses economic intuition over formal proofs. It 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. 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. Part 2 introduces us to The Generalized Method of Moments (GMM) approach to free parameter selection, distribution estimation, and model evaluation. In Part 3, Cochrane covers option pricing and term structure of interest rate models. 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. 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.