The Affect Heuristic and Stock Ownership: A Theoretical Perspective
59 Pages Posted: 15 Jan 2017 Last revised: 20 Apr 2018
Date Written: March 24, 2018
We consider a setting where owning stock confers direct utility due to an affect heuristic. Specifically, holding equity in companies with visible brands or environmentally conscious products yields positive consumption benefits, whereas investing in sin stocks yields the reverse. We find that stock prices deviate from expected fundamentals even when assets are in zero net supply. Stocks that yield high direct utility are, on average, more informationally efficient as they stimulate more entry into the market for these stocks and, consequently, more information collection. The analysis also accords with a value effect, high valuations of brand-name stocks, abnormally positive returns on sin stocks, volume premia in the cross-section of returns, proliferation of mutual funds and ETFs, and yields untested implications. If, as psychological literature suggests, agents derive greater utility from successful companies then asset prices react to public signals non-linearly, leading to booms and busts, as well as crashes and recoveries.
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