“Affect” is the term used in behavioral finance to refer to automatic feelings investors feel toward a specific company or investment. It is, in a sense, the gut reaction one has to the company itself.
Affect is known to play a role in the pricing of many assets such as cars, houses and watches. In a Perspective presented in the March/April 2008 Financial Analysts Journal Statman, Fisher and Anginer examine the role of affect in investment valuation.
Using the Fortune magazine list of most admired companies, the authors form two portfolios: one consisting of “Admired” companies and the other consisting of “Spurned” companies. They found that the spurned companies generated higher returns than admired companies, even after adjusting for CAPM risk.
The authors also find that subjective risk is associated with negative affect. While objective risk factors such as those used in the CAPM or the Fama-French 3 factor model typically assume that higher risk will lead to higher returns, the authors posit that higher perceived risk, manifest as low affect, is also associated with higher return.For more information, see all articles on: Behavioral Finance, Investing in Stocks, Investment Returns, Valuation See also: