Abstract
Investment practitioners often interpret an excessively high price-earnings ratio as a reflection of an overvalued market fuelled by optimistic investor sentiment. We examine the role of investor sentiment in explaining the P/E ratio in the G7 countries. The results suggest that after controlling for the effects of fundamental factors, the P/E ratio generally increases with an improvement in investor sentiment. The robustness of the findings to the use of forward P/E ratios, alternative data frequency, and controlling for financial crises is checked. Furthermore, the results from quantile regressions reveal that the effects of investor sentiment vary across the P/E quantiles.
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