The affect heuristic and stock ownership: A theoretical perspective

Jiang Luo and Avanidhar Subrahmanyam

Review of Financial Economics, 2019, vol. 37, issue 1, 6-37

Abstract: We consider asset prices and informational efficiency in a setting where owning stock confers direct utility due to an affect heuristic. Specifically, holding equity in brand name companies or those indulging in “socially desirable” activities (e.g., environmental consciousness) confers positive consumption benefits, whereas investing in “sin stocks” yields the reverse. In contrast to settings based on wealth considerations alone, expected 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 by “basking in reflected glory,” then asset prices react to public signals non‐linearly, leading to booms and busts, as well as crashes and recoveries.

Date: 2019
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