What does the behavioral approach to asset pricing include in its valuation methodology?

The behavioral approach to asset pricing incorporates the concept of investor sentiment as a critical component of its valuation methodology. This approach recognizes that investor behavior, influenced by biases, emotions, and social factors, can lead to deviations from traditional economic theory and rational decision-making.

Investor sentiment encompasses the psychological factors that drive investors' perceptions and reactions to market information. For example, periods of exuberance may lead to inflated asset prices, while fear can result in excessive selling. The behavioral approach seeks to understand how these sentiments affect asset prices, acknowledging that investors do not always act rationally or in accordance with available information.

This methodology contrasts with strictly quantitative approaches that focus solely on numerical data, historical price trends, or long-term forecasts. While quantitative data and market predictions can inform the analysis, the behavioral approach emphasizes the role of investor psychology in the pricing of assets, providing a more comprehensive view that considers human emotions and biases alongside traditional financial metrics.