Affect in a Behavioral Asset Pricing Model

“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:
  • What is Behavioral Finance?
  • Estimating the Market Risk Premium Using Arbitrage Pricing Theory
  • The Capital Asset Pricing Model (CAPM)
  • Collective Wisdom in the Stock Market
  • Estimating the Required Return on a Stock Using the Bond-Yield Plus Risk Premium Method
  • Technical Analysis Explained : The Successful Investor's Guide to Spotting Investment Trends and Turning Points

    The Intelligent Investor: The Classic Text on Value Investing

    Financial Statement Analysis: A Practitioner's Guide, 3rd Edition

    Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)

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