We develop a positive behavioral portfolio theory (BPT)and explore its implications for portfolioconstrution and security design. The optimalportfolios of BPT investors resemble combinations ofbonds and lotterly tickets consistent with Friedmanand Savage's (1948) observation. We compare the BPTefficient frontier with the mean-variance efficientfrontier and show that, in general, the twofrontiers do not coincide. Optimal BPT portfoliosare also different from optimal CAPM portfolios. Inparticular, the CAPM two-fund separation does nothold in BPT. We present BPT in a single mentalaccount version (BPT-SA) and a multiple mentalaccount version (BPT-SA). BPT-SA investors integratetheir portfolios into a single mental account, whileBPT-SA investors segregate their portfolios intoseveral mental accounts. BPT-SA portfolios resemblelayered pyramids, where layers are associated withaspirations. We explore a two-layer portfolio wherethe low aspiration layer is designed to avoidpoverth while the high aspiration layer is designedfor a shot at riches.

This paper examines the profitability of momentumstrategies implemented on international stock marketindices. Our results indicate statiscallysignificant evidence of momentum profits. Themomentum profits arise mainly from time-seriespredictability in stock market indices—very littleprofit comes from predictability in the currencymarkets. We also find higher profits for momentumportfolios implemented on markets with higher volumein the previous period, indicating that returncontinuation is stronger following an increase intrading volume. This result confirms theinformational role of volume and its applicabilityin technical analysis.

We analyze the dividend behaviour of the aggregatestock market. We propose a model that assumesmanagers minimize the costs of adjustment associatedwith being away from their target dividend payout.The target is expressed as a function of laggedstock prices and permanent earnings, generalizingprevious models of dividend behaviour. We present anew method for measuring unobserved permanentearning based on the Kalman filter. Ourspecification of dividend behaviour is stronglysupported by the data relative to both alternativemodels and over time. We find significant evidenceof dividends conveying information regardingunexpected positive changes in current permanentearnigs. We also find that both the speed ofadjustment of dividends to target dividends andtests of signaling are sensitive to thespecification of the model.

I introduce two-factor discrete time stochasticvolatility models of the short-term interest rate tocompare the relative performance of existing andalternative empiricial specificattions. I develop anonlinear asymmmetric framework that allows forcomparisons of non-nested models featuringconditional heteoskedasticity and sensitivity of thevolatility process to interest rate levels. A newclass of stochastic volatility models withasymmetric GARCH models. The existing models arerejected in favor of the newly proposed modelsbecause of the asymmetric drift of the short rate,and the presence of nonlinearity, asymmetry, GARCH,and level effects in its volatility. I test thepredictive power of nested and non-nested models incapturing the stochastic behavior of the risk-freerate. Empirical evidence on three-, six-, and12-month U.S. Treasury bills indicates but thattwo-factor stochastic volatility models are betterthan diffusion and GARCH models in forecasting thefuture level and volatility of interest ratechanges.

We examine the impact of merger announcements onprotfolios of acquiring firm and target firm commonstock from 1919 to 1930. despite vast changes in theeconomic and regulatory environment, overallacquisition profitability has remained remarkablyconstant over the last 70 and 80 years. Target firmshareholders in the 1920s clearly gained fromtakeovers, averaging abnormal retruns in excess of15%, while acquiring firm shareholders essentiallybroke even. synergistic or monopolistic gains fromconsolidation were minimal. Unlike the more recentexperience, target firm and acquiring firm abnormalreturns were largely unaffected by the mode ofacquisition, the means of financing, or the degreeof industrial relatedness.

This study examines the stock market forecasts andportfolio allocation decisions of small individualinvestors, based on survey data for 1987–1994. Wheninvestors are bullish, they increase their equityholdings; when investors are bearish, they decreaseequity holdings. The surveyed investors are unableto time the stock market successfully. However, theshifts in their portfolios reflect past marketmovements and are consistent with positive feedbacktrading.