Affect in a Behavioral Asset Pricing Model

Abstract

Stocks, like houses, cars, watches and most other products exude affect, good or bad, beautiful or ugly, admired or despised. Affect plays a role in pricing models of houses, cars and watches but, according to standard financial theory, affect plays no role in pricing of financial assets. We outline a behavioral asset pricing model where expected returns are high when objective risk is high and also when subjective risk is high. High subjective risk comes with negative affect. Investors prefer stocks with positive affect and their preference boosts the prices of such stocks and depresses their returns.

Keywords: asset pricing models, market efficiency, behavioral finance, emotions, cognitive biases

JEL Classification: G11, G12, G14