‘Value’ Fueled By Behavior Bias

The financial equivalent of the Miller Lite, “tastes great, less filling,” debate is between traditional finance (which uses risk theories to explain asset pricing), and the newer behavioral finance field (which uses human behavior to provide the explanations).

Unfortunately, there’s no consensus about which side of the debate is correct. My own view is that both have much to contribute to the discussion. In other words, the story isn’t all one-sided—it’s not black or white. Instead, it’s some shade of gray.

Hersh Shefrin, one of the leaders in the field of behavioral finance, contributes to the literature with his May 2014 paper “Investors’ Judgments, Asset Pricing Factors, and Sentiment.” In his research, Shefrin uses a metric called “investment sentiment”—a measure of investor optimism developed by Malcolm Baker and Jeffrey Wurgler.

The investor sentiment index is based on a number of measures, including trading volume as measured by New York Stock Exchange turnover; the dividend premium (the difference between the average market-to-book ratio of dividend payers and nonpayers); the closed-end fund discount; the number of and first-day returns on IPOs; and the equity share in new issues.

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