Political sentiment and MAX effect

Abstract

The well-known “MAX effect” documents that stocks with high maximum daily returns in the past month underperform those with low maximum daily returns. We show that such an effect varies with firm-level political sentiment. Among firms with low political sentiment, the usual MAX strategy gives a monthly risk-adjusted return of 1.52% and is statistically significant. However, the MAX effect weakens substantially or even reverses for firms with high political sentiment. Our findings provide novel guidance for trading on the MAX effect. Moreover, the results challenge the usual sentiment-based explanation for the MAX effect. Further evidence suggests that the prospect theory or investors’ underreaction to news may be consistent with our findings, although these channels cannot empirically explain the impact of political sentiment.