Firm-Level Versus Aggregate Market Investor Sentiment: What Matters Most for Corporate Announcement Returns

Abstract

Noise trader models of market behaviour propose that investor sentiment affects market responses to corporate announcements. As beliefs can be cross-sectionally heterogeneous, firm-specific investor sentiment may differ from aggregate levels of investor sentiment. Previous studies, which focus exclusively on market-level investor sentiment measures, are likely to have under-stated the economic magnitude of the role that sentiment plays in corporate announcement returns. We provide the first theoretical model for the relative importance of firm- and market-level investor sentiment for corporate announcement returns. We also demonstrate empirically that firm-level investor sentiment has marginal explanatory power beyond market-level investor sentiment for merger and acquisition announcement returns, turnover and long-run reversals. It is also shown that firm-level investor sentiment dominates when there is high divergence in investor sentiment across firms, whereas the effect of market-level investor sentiment increases during hot market periods.