Periods Of High Sentiment Research Articles

Certainty of uncertainty for asset pricing

Uncertainty is known to be crucial in asset pricing, yet evidence from a comprehensive analysis of various uncertainty measures remains sparse. By machine learning, we construct a novel economic uncertainty index derived from a heterogeneous range of uncertainty measures and investigate its predictability of stock returns. Our composite uncertainty index exhibits robust in- and out-of-sample predictability of stock market returns over the one- to 12-month horizon. The predictive power stems from the volatility-orthogonal components of individual uncertainty measures and becomes more pronounced during high uncertainty and high sentiment periods. The predictability of our economic uncertainty index aligns with theoretical frameworks linking uncertainty to future investment, cash flows, and market expectations.

Timing sentiment with style: Evidence from mutual funds

This study analyzes four distinct types of mutual fund sentiment timing skills using a multifactor framework. Our results indicate a diminished significance of market sentiment timing, in contrast to the results of prior studies. Additionally, we reveal that size and value sentiment timing can substantially enhance fund performance. Managers strategically reduce their exposure to small stocks using size sentiment timing and increase exposure to value stocks through value sentiment timing during high sentiment periods. We find no evidence that mutual fund managers engage in momentum sentiment timing.

State-dependent intertemporal risk-return tradeoff: Further evidence

We suggest that the intertemporal risk-return tradeoff is not necessarily positive but rather state dependent. We further explore the state dependent risk-return relation by examining how the positive risk-return relation is distorted in response to various market conditions, including extreme price changes, differing levels of investor sentiment, the introduction of stock options, and throughout business cycles. The tendency for uninformed investors to be optimistic (pessimistic) in response to good (bad) market news cause overpricing (underpricing), and the resulting trade activity of arbitrageurs that distorts the positive risk-return tradeoff, is documented consistently across these environments. We find that the attenuation (reinforcement) of the positive risk-return relation under investors’ optimistic (pessimistic) expectations is stronger in high (low) sentiment periods, in the presence of extreme returns, in the period after stock options became available, and during expansionary periods. We argue that the asymmetric intertemporal risk-return relation is a consequence of rational arbitrageurs’ trading to exploit mispricing through the selling of overpriced stocks conditional on good news and buying underpriced stocks conditional on bad news.

Institutional herding and investor sentiment

We investigate the role of investor sentiment in institutional herding behavior and its impact on stock prices. We find that institutional investors exhibit more herding behavior during periods of high sentiment, which has a significant impact on stock prices. Our results show that herding has a stabilizing effect on the stock market when investor sentiment is low, while it causes price distortions when sentiment is high. We also show that the impact of sentiment on price is particularly pronounced for small, non-profitable, low tangibility, high-growth firms.

Manager sentiment and conditional conservatism

AbstractThis study examines the effect of manager sentiment on conditional conservatism. Manager sentiment refers to widely held beliefs of financial managers about their firms’ future economic prospects that are not justified by available economic fundamentals. Manager sentiment is likely to affect conditional conservative reporting because the decision to recognize unrealized economic losses in a timely manner flows from financial managers’ beliefs about their firms’ future cash flow prospects. We predict and find that manager sentiment is negatively associated with conditional conservatism, indicating that firms report less conservatively during periods of high manager sentiment (over‐optimism) and more conservatively during periods of low manager sentiment (over‐pessimism). Moreover, the effects of manager sentiment on conditional conservatism remain strongly negative after controlling for manager overconfidence. We further find that asset write‐offs are lower during high sentiment periods but higher in subsequent periods. Importantly, the manager sentiment effect on conservatism is incremental, and the opposite in sign, to the effect of investor sentiment, which has not been demonstrated in prior literature.

Geographic links and predictable returns

AbstractUsing establishment‐level data of U.S. public firms, we construct a novel measure of geographic linkage between firms. We show that the returns of geography‐linked firms have strong predictive power for focal firm returns and fundamentals. This effect is distinct from other cross‐firm return predictability and is not easily attributable to risk‐based explanations. It is more pronounced for focal firms that receive lower investor attention, are more costly to arbitrage, and during high sentiment periods. The cross‐firm information spillovers and return predictability are also stronger for geographic peers with economic linkages and with positive information. Our results are broadly consistent with sluggish price adjustment to nuanced geographic information.

Effect of sectoral holdings on the flow-performance sensitivity of mutual funds

We find that the flow-performance sensitivity (FPS) of mutual funds depends on the composition of their sectoral holdings. We use the Morningstar classification of fund holdings into the following three Super Sectors: Defensive, Sensitive, and Cyclical. On average, the FPS decreases as the fraction of defensive or sensitive stocks increases in the fund’s portfolio. The FPS increases as the fraction of cyclical stocks increases. During high sentiment periods, the sensitivity of new sales as well as redemptions increases, resulting in overall higher FPS for all funds. However, in both the low and the high sentiment periods, the FPS is lower for funds with a higher fraction of defensive or sensitive stocks and higher for funds with a higher fraction of cyclical stocks. Investors with a long investment horizon may wish to avoid mutual funds that invest primarily in cyclical stocks as funds with high FPS tend to have high liquidity costs.

Aggregate Investor Sentiment and Time-Varying Price Discovery: Evidence from the Options Market

Previous literature shows that the price-discovery ability of options market varies substantially over time. Using data of Shanghai Stock Exchange 50 exchange-traded fund options, this paper shows that options prices contribute relatively less to price discovery during low-sentiment periods, but the price-discovery ability of options market remains unchanged during high-sentiment periods. These results suggest that change in aggregate investor sentiment is an important source of the time variation in options’ price discovery ability. Moreover, the options market experiences greater bid-ask spreads when investor sentiment is lower, supporting a “transaction costs mechanism.” This paper fulfills related literature on the time variation in options’ price-discovery ability.

Investor sentiment and firm capital structure

We provide novel evidence of the role of investor sentiment in determining firms' capital structure decisions from three perspectives: leverage ratio, debt maturity and leverage target adjustment. We find that when investor sentiment is high, firms increase their leverage ratios, supporting our contention that high investor sentiment increases firms' debt capacity and facilitates the use of an aggressive leverage policy. Debt maturity is shorter in high sentiment periods, implying that firms are confident about future earnings and use shorter debt maturity to signal their financial solvency. Leverage target adjustment is slower in low sentiment periods, indicating higher costs of external finance. Furthermore, the sentiment-leverage relationship sensitivity is greater for financially constrained firms. Our extended analysis determines that leverage-increasing firms generate lower stock returns subsequent to a period of high sentiment, offering practical insights into the economic consequences of increasing leverage in high sentiment periods on corporate value for investors. Our research advances the understanding of the impact of investor sentiment on firms' financing decisions and stock returns.

Investor sentiment and stock market anomalies in Australia

By constructing the first Australian investor sentiment index, this study explores the role of sentiment in explaining stock market anomalies. The Australian investor sentiment index is in line with the fluctuation of global economic trends and is highly correlated with the US sentiment index. We also explore the explanatory power of investor sentiment over Australian stock market anomalies. Our findings underscore the importance of investor sentiment in Australia, whereby anomaly returns are stronger following high sentiment periods. The short legs of each strategy account for a larger proportion of anomaly returns when investor sentiment increases. Further, sentiment does not significantly influence returns on the long legs of anomalies.

China's illiquidity premium: Due to risk-taking or mispricing?

This study focuses on China's A-share market and investigates the existence and underlying source of the illiquidity premium. We observe a significant and positive relationship between stock illiquidity and expected returns. Moreover, relative to illiquid stocks, liquid stocks are more susceptible to overpricing during high sentiment periods and earn lower abnormal returns following high sentiment periods, thus supporting the sentiment-driven mispricing explanation. We also find evidence that the illiquidity premium fails to reflect exposure to underlying risk. Overall, China's illiquidity premium derives from mispricing instead of risk-taking.

Fund-level Investor Sentiment and Mean-variance Relation: Evidence From Singapore-listed ETFs

This paper tests the influences of fund-level sentiment on the mean-variance relation in ETF market. We find that in low (high)-sentiment periods, the expected excess return is positively (negatively) related to the conditional variances. Sentiment traders undermine the otherwise positive risk-return tradeoff and even twist it into a negative one in high-sentiment periods. The impact of sentiment is stronger during the global pandemic.

CEO political connection and stock sentiment beta: Evidence from China

This study examines the impact of CEO political connection on stock sentiment beta. We theorize that CEO political connection contributes to elevated stock sentiment sensitivity because investors overvalue executives' political connection in a transitioning economy. Panel regression results with data of Chinese listed companies from 2009 to 2019 support our hypotheses. The impact of CEO political connection on stock sentiment risk is more pronounced during high sentiment periods and among non-state-owned enterprises. Investors often ignore politically connected CEOs' deficiency in internal management reflected by low quality internal information, ineffective supervision and control, and high management risk. These deficiencies contribute to higher stock sentiment beta. Noise trading uplifts stock sentiment beta, especially for companies with politically connected CEO. Encouragingly, the national anti-corruption campaign has curbed investors' adulation of political connections. This study warns investors and corporate boards against CEO political connection and calls for a more prudent treatment.

ANALYST FORECAST DISPERSION, INVESTOR SENTIMENT, AND THE CROSS-SECTION OF STOCK RETURNS

This paper explores the role investor sentiment plays in the relationship between analyst forecast dispersion and stock returns. With short sale constraints, stock prices are determined by the optimistic investors. There are more optimistic investors during the high sentiment periods when investors suffer more from psychological bias. This is the first paper to document that following the high sentiment periods, stocks with the most analyst forecast dispersion are overpriced, earning significantly negative returns, while those with the least analyst forecast dispersion are not overpriced as the degree of belief dispersion is low. However, following the low sentiment periods, both are not overpriced. A portfolio that longs the least dispersed stocks and shorts the most dispersed stocks yields significantly positive returns only following the high sentiment periods. My findings can potentially reconcile the puzzling risk effect and mispricing effect in the literature. The risk (mispricing) effect suggests a positive (negative) relation between analyst forecast dispersion and future stock returns. Presumably, the magnitude of the mispricing effect depends on the proportion of irrational investors and their bias, which is positively related to investor sentiment. During the high sentiment period, the mispricing effect takes over, and the overall effect is negative. During the low sentiment period, the percentage of irrational investors is mediate, and the mispricing effect and the risk effect counter each other, leading to insignificant relation.

Investor sentiment, style investing, and momentum

Investor sentiment is an important condition for style investing in affecting asset price predictability. We find that style returns have predictive power for future stock returns in high sentiment periods, but not low sentiment periods. The correlation between style returns and stock returns explains the variation in momentum profits in high sentiment periods, but not low sentiment periods. Sentiment has an interaction effect with style returns, but not market returns. While positive style returns predict future stock returns under high sentiment, negative style returns do not. The effect of investor sentiment on style investing is independent of prior market returns.

Sentiment and Style: Evidence from Republican Managers

This study examines the relationship between corporate managers’ political ideology and corporate leverage policies conditional on investor sentiment. Based on a minimum of 21,884 observations over the 1992–2008 period, the authors show that Republican managers significantly reduce leverage during periods of high investor sentiment. To the best of the authors’ knowledge, this paper is the first to document that Republican managers are not swayed by the general tendency to increase leverage in high-sentiment periods. Overall, the empirical evidence from this study indicates that personal characteristics of managers have a consistent impact on corporate policies, providing support for the “behavioral consistency” theory. Further, the results of this study imply that internal and external stakeholders of a corporation should take into account manager personality in their decisions. For example, the board of a highly indebted company may consider hiring a conservative manager to reduce its financial risk.

News sentiment and stock return: Evidence from managers’ news coverages

In this paper, we construct a monthly news-based manager sentiment (SM) based on the tone of managers’ news reports. Statistically, SM has excellent predictability for the subsequent month's return in both in- and out-of-sample periods. we find that SM contains additional information to forecast stock returns compared to popular economic predictors. After analysing the prediction performance at different sentiment levels, it is found that the prediction power of SM is far better in the high sentiment period than in the low sentiment period. In terms of investing, SM also generates considerable economic value for investors who use forecasting information to optimise their stock portfolios.

Investor Sentiment and Paradigm Shifts in Equity Return Forecasting

This study investigates the impact of investor sentiment on excess equity return forecasting. A high (low) investor sentiment may weaken the connection between fundamental economic (behavioral-based nonfundamental) predictors and market returns. We find that although fundamental variables can be strong predictors when sentiment is low, they tend to lose their predictive power when investor sentiment is high. Nonfundamental predictors perform well during high-sentiment periods while their predictive ability deteriorates when investor sentiment is low. These paradigm shifts in equity return forecasting provide a key to understanding and resolving the lack of predictive power for both fundamental and nonfundamental variables debated in recent studies. This paper was accepted by David Simchi-Levi, finance.

Concept links and return momentum

Unlike traditional asset categories (e.g., industry classifications) that are generally defined clearly, some groups of stocks are tied to certain loosely defined “concepts” (e.g., e-commerce). When investors find it difficult to analyze ambiguous concept-oriented information, information diffuses slowly, creating “concept momentum”. Based on unique concept data in the Chinese stock market, this study constructs a concept-momentum strategy that involves buying stocks from past winning concepts and selling stocks from past losing concepts, which can generate pronounced abnormal returns. Neither risk factors, firm-level momentum, nor industry-level momentum can explain concept momentum. Furthermore, we find that both the underreaction and cross-stock lead-lag effect channels can cause slow information diffusion and drive concept momentum. Moreover, the concept momentum effect is stronger for relatively ambiguous concepts, for concepts that attract less investor attention, and following high-sentiment periods.

Do the Securities Analysts Play the Role of Information Competition or Information Supplement? Empirical Analysis Based on Investor Sentiment

The purpose of this article is to investigate the role of securities analysts in Chinese stock market. Taking the earnings announcements of listed companies, analysts’ earnings forecast and analysts’ recommendations in Chinese stock markets from 2014 to 2018 as the samples, this paper explores the influence mechanism of investor sentiment on the market reaction to announcements, and investigates the influence mechanism of investor sentiment on the role of securities analysts under the framework of behavioral finance theory. On the basis of theoretical analysis, this paper empirically tests the relationship between the information content of analysts’ reports and the information content of the earnings announcements from the perspective of behavioral finance, and discusses the role of securities analysts in the stock market. The results show that during the periods of high investor sentiment, securities analysts do not demonstrate the role of information competition or information supplement. On the other hand, during the periods of low investor sentiment, securities analysts play the role of information competition or information supplement. Furthermore, after excluding the investor sentiment component of the market reaction to announcements, securities analysts do not demonstrate the role of information competition, but play the role of information supplement. The findings of this study offer new insights into the role securities analysts play in Chinese stock market, which is conducive to improving the quality of analysts’ reports, thus enhancing the efficiency of the securities market.