Abstract
We study how investor sentiment affects real investment. We find that both investment and external finance increase with sentiment. The relation between q and investment increases with sentiment, while the relation between cash flow and investment declines with sentiment. These findings suggest that sentiment both creates and alleviates financial constraints. We find that investment in low sentiment states leads to increases in operational efficiency, whereas investment in high sentiment states leads to declines in operational efficiency. Investment and external finance in high sentiment states predict worse stock returns than investment and external finance in low sentiment states. The findings suggest that investor sentiment creates inefficiencies in the allocations of both financial and real resources.
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