Abstract
Based on the underestimation model in bear markets and the overestimation model in bull markets, we propose two types of sentiment asset pricing models to study the effects of investor sentiment on stock prices and limit of arbitrage. The two sentiment asset pricing models demonstrate that investor sentiment has a systematic and significant impact on stock prices; furthermore, investor sentiment plays a significant role on the limit of arbitrage. We find that our framework can be helpful in understanding a range of financial anomalies: overreaction, underreaction, the fire sales and the limit of arbitrage.
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