Abstract
We show that market sentiment shock creates demand shock for risk assets and is a systematic risk for assets. We measure market sentiment shock as the unexpected portion of the University of Michigan Consumer Sentiment Index’s growth. This shock prices stock returns in the Arbitrage Pricing Theory (APT) framework at 1% after controlling for market, size, value, momentum, and liquidity risk factors. Its premium lowered the implied risk aversion by 97.9% to 11.46 between 1978 and 2009 in our Sentiment CCAPM. Merton’s (1973) ICAPM reconfirms our finding that market sentiment shock is a systematic risk factor that provides investment opportunities.
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