Perspectives-Affect in a Behavioral Asset-Pricing Model

Abstract

Stocks, like houses, cars, watches, and other products, exude affect - that is, they are considered good or bad, beautiful or ugly; they are admired or disliked. Affect plays an overt role in the pricing of houses, cars, and watches, but according to standard financial theory, it plays no role in the pricing of financial assets. This article outlines a behavioral asset-pricing model in which expected returns are high not only when objective risk is high but also when subjective risk is high. High subjective risk comes with negative affect. Investors prefer stocks with positive affect, which boosts the prices of such stocks and depresses their returns.

Keywords: Equity Investments, Fundamental Analysis and Valuation Models, Investment Theory, CAPM, APT, and Other Pricing Theories, Behavioral Finance

JEL Classification: G12, G14