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.