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In my Letter From the Board in the April/May issue,
I discussed the concept of popularity as a
way of bridging classical and behavioral finance
(Kaplan 2018). Yale's Roger Ibbotson and
Morningstar's Thomas Idzorek introduced the
concept of popularity (Ibbotson and Idzorek
2014, Idzorek and Ibbotson 2017), and I formalized
the idea in the popularity asset pricing model,
or PAPM. All of us, with Morningstar's James
Xiong, have written a monograph for the
CFA Institute Research Foundation that goes into
depth on popularity (Ibbotson, et al. 2018).

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In that Letter From the Board, I gave a high-level
introduction to the PAPM. The PAPM is a model
that I developed of how security prices and
expected returns are formed when investors
care about security characteristics other than risk
and expected return.

Before getting into the details of the PAPM, let us
review the concept of popularity. In the Letter
From the Board, I explain:

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considerations can be ignored.
2 All investors use mean-variance optimization,

or MVO, as described by Markowitz (1952, 1959,
1987) to select their portfolios.
3 All investors have the same forecasts; i.e., the

same capital-market assumptions (expected
returns, standard deviations, and correlations).
4 All investors can borrow and lend at the same

risk-free rate without limit.

EXHIBIT 1

Equilibrium Under the CAPM
Expected Return
25%

Securities

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Investor 3

MAR
I TA L
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C

Investors 1 & 2

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KET

LINE

E F F IC IE

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T IE R
NT FRON

D

B
C

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E

Market Portfolio

5

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1 Taxes, transaction costs, and other real-world

"Investors are willing to pay more for securities
with popular characteristics and less for securities
with unpopular characteristics. This causes
popular stocks to have lower returns and unpopular
stocks higher returns. Thus, investors who are
willing to hold unpopular stocks will, over
the long run, earn higher returns than other
investors ... The beauty of the idea of popularity
is that it applies to all security characteristics,
whether concern for them is rational or

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ISO 12647-7 Digital Control Strip 2009

As I discuss, the PAPM is an extension to
the CAPM. However, the addition of components
that model popularity leads it to some very
different conclusions.
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Review of the CAPM 1
Because the CAPM is the prevailing asset pricing

theory and because it is the basis of the
PAPM, let's review it before presenting the PAPM.
The CAPM is based on several assumptions:

Because these characteristics can be considered
to be popular or unpopular, the PAPM
provides a formal model of asset pricing in which
popularity plays a role. In this issue of Quant
U, I present the key assumptions and conclusions
of the PAPM and contrast them with the
best-known asset pricing model, the capital asset
pricing model, or CAPM.

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irrational. Thus, popularity encompasses both
rational and behavioral explanations of
market phenomena. This is how popularity serves
as a bridge between the rational and behavioral
schools of finance."

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QUAN T U

Paul D. Kaplan

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The Popularity Asset Pricing Model
An extension of the CAPM
but with very different conclusions.

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Standard Deviation

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Source: Morningstar.

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1 The remainder of this article is based on Chapter 5 in Ibbotson, et al. 2018.

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Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2018
