Sentiment Periods Research Articles

Value at Risk, Cross-Sectional Returns and the Role of Investor Sentiment

In this paper, we find that the relationship between the value-at-risk (VaR) and expected returns is negative and this negative relationship between the VaR and expected returns can be explained by volatility in the U.S. market. However, for different levels of investor sentiment, this relationship changes. For a high sentiment period, VaR is negatively related with the expected return and cannot be explained by momentum, short-term reversal, volatility, and financial distress. In comparison, the relation between the VaR and expected returns during a low sentiment period is mixed.

Does investor sentiment affect stock price crash risk?

ABSTRACTThis study investigates the effect of investor sentiment on future stock price crash risk. Using a large sample of U.S. firms for the period 1991–2014, we find that firms are associated with greater likelihood of stock price crashes in high-sentiment period. The impact of investor sentiment on crash risk is more pronounced in firms with higher leverage ratio, greater default risk and larger analyst forecast dispersion. Overall, the results suggest that firm-level negative information is more likely to be withheld during high investor sentiment period, thus leading to a larger stock price crash risk.

Market sentiment and firm investment decision-making

While research on factors driving corporate investment decisions has blossomed, knowledge related to the Chief Executive Officer's (CEO's) market sentiment on investment decision outcomes is lacking. In this study, we extend the existing corporate finance literature by examining the underexplored issue of how CEOs' market sentiment drives firms' investment decisions. Capitalising on a large sample of US firms for the period 2004–2014, we uncovered some crucial observations. First, we found empirical support for our theoretical contention that market sentiment drives corporate investment decisions. Second, we established that, while financial flexibility induces managers to overinvest, the expectation of future profitability leads firms to underinvest during high sentiment periods. In addition, we uncovered that the 2007/08 financial crisis significantly impacted firm behaviour and realigned managerial decision-making. Thus, the sentiment-investment relationship is more pronounced during the crisis and the post-crisis periods. Our results are robust after accounting for the possibility of endogeneity and using alternative measures of both CEOs' market sentiment and firm investment.

Sentimental Mutual Fund Flows

We show that many stylized empirical patterns for mutual fund flows are driven by investor sentiment. Specifically, when sentiment is high, investors exhibit a stronger tendency of chasing past fund performance; fund flows are less sensitive to fund expenses; and investors are attracted more to funds with sheer visibility. Moreover, the well-documented positive relation between fund flows and future fund performance is significant only during high sentiment periods and is mainly driven by expected component of fund flows. Finally, we show that mutual fund investors exhibit a significantly negative timing ability at the individual fund level when sentiment is high.

Pension discount rate and investor sentiment

PurposeThe purpose of this paper is to examine how investor sentiment, proxied by Michigan consumer confidence index, affects the choice of defined benefit pension plan discount rates.Design/methodology/approachThe authors use multivariate analysis to test our hypotheses. The dependent variable is defined pension plan discount rate and the testing variables are investor sentiment and a dummy variable representing underfunded status.FindingsThe authors find a negative and significant relation between investor sentiment and pension plan discount rate. During high (low) sentiment periods, pension discount rate tends to be adjusted downward (upward) discretionarily. Further analysis indicates the relationship between pension discount rate and investor sentiment is more pronounced for firms with underfunded pension plans. The results can be explained by limited attention effects, capital budgeting strategy and earning smoothing.Practical implicationsThe empirical results of this study have important implications for corporate governance and regulation. Specifically, the results suggest the need for increased attention from boards of directors, auditors and regulators to reported pension liabilities, especially during periods of high investor sentiment when pension plan sponsors are more likely to adjust down pension discount rate and accordingly to increase pension liabilities.Originality/valueThe paper contributes to the extant literature by identifying investor sentiment as a new incentive of pension discount rate manipulation. The empirical results of this study also have important implications for corporate governance and regulation.

Fund Management Skill and Noise Trading

In this research authors show that institutional investors’ skill matters the most during high sentiment periods when market signals are noisy. The results reveal that fund managers with the highest (lowest) skill add (lose) $7.71 ($5.64) million of value during high sentiment periods, compared with $3.74 million gain realized by the average manager during the entire sample period. When the market sentiment is low, high-skilled fund managers incur a value loss of only $0.18, much smaller than the $30.32 million loss realized by their low-skilled counterparts.

Sentimental mutual fund flows

AbstractWe show that many stylized empirical patterns for mutual fund flows are driven by investor sentiment. Specifically, when sentiment is high, investors exhibit a stronger tendency of chasing past fund performance; fund flows are less sensitive to fund expenses; and investors are attracted more to funds with sheer visibility. Moreover, the well‐documented positive relation between fund flows and future fund performance is significant only during high sentiment periods and is mainly driven by expected component of fund flows. Finally, we show that mutual fund investors exhibit a significantly negative timing ability at the individual fund level when sentiment is high.

Voluntary Disclosure and Investor Sentiment

We develop firm-specific voluntary and mandatory disclosure measures using information provided by firms in their 8K filings. Our measures allow for much broader coverage in the time-series and crosssection of firms relative to prior disclosure measures — depending on the prior measure used, we double or triple the sample size. We also show that an 8K-based voluntary disclosure measure subsumes voluntary prior disclosure measures employed (e.g., management forecasts, non-GAAP earnings, conference calls) and captures additional variation. We also document a positive association between our 8K-based voluntary and mandatory disclosure measures and firm characteristics frequently linked to overall firm disclosure. To support the usefulness of our measures, we reexamine the link between voluntary disclosure and investor sentiment, a theoretical relation with mixed empirical results in the literature. We find a negative relation between voluntary disclosure and investor sentiment, consistent with managers increasing disclosure to correct low-sentiment induced mispricing, even after controlling for the level of mandatory disclosure. Consistent with this story, mispricing is corrected more for firms that increase their corporate voluntary disclosure following low sentiment periods.

Investor sentiment, SEO market timing, and stock price performance

Abstract This article details an investigation of the impact of investor sentiment on the probability of firms conducting seasoned equity offerings (SEOs) and on stock price performance around and subsequent to SEOs. The results show that investor sentiment has a positive impact on SEO probability and that this impact is stronger for small and young firms. Furthermore, firms conducting SEOs during high sentiment periods experience less severe short-run price drops around the issuance yet more severe post-issue long-run underperformance, compared with firms conducting SEOs during low sentiment periods. These effects of investor sentiment on stock price performance are stronger for small, young, and high market-to-book ratio firms.

Forecasting Excess Returns and Abnormal Trading Volume using Investor Sentiment: Evidence from Chinese Stock Index Futures Market

ABSTRACTWe examine the ability of investor sentiment to forecast excess returns and abnormal trading volumes in Chinese stock index futures market. Based on prior research on investor sentiment, we expect investor sentiment to forecast excess returns and abnormal trading volumes, and also expect that highly volatile sentiment period and low margin requirement period will be more sensitive to investor sentiment than lowly volatile sentiment period and high margin requirement period. In a sample of CSI 300 index futures over the period 2010–2014, we find that, over a daily horizon, stock index futures sentiment reliably predicts excess returns and abnormal trading volumes, and that the sensitivity of returns and trading volumes to sentiment is more significantly positively related to the highly volatile sentiment period and low margin requirement period. Moreover, we run a VAR model and analyze the Granger causality of the system. We also find the ability of investor sentiment to cause the change of excess returns and abnormal trading volume in the daily horizon.

A Surprise That Keeps You Awake: Overnight Returns After Earnings Announcements

I dissect stock returns after earnings announcements into their overnight and intraday components and document strong positive abnormal overnight returns for several weeks after both large positive and negative earnings surprises. This finding is in line with attention-induced buying pressure. Consistently, overnight returns are higher when retail investor attention towards the surprise is high. Corresponding intraday returns have the opposite sign, which makes this pattern invisible in close-to-close returns. The effect is stronger during high sentiment periods as well as for hard-to-arbitrage firms and weaker if the average investor holds the stock at a gain.

Maxing Out in China: Optimism or Attention?

AbstractBali et al. (2011) document a maximum daily returns (MAX) premium in the US where stocks with the highest MAX underperform stocks with the lowest MAX in the subsequent month. However, the source of this MAX premium is contentious. Fong and Toh (2014) find that the MAX premium exclusively follows high sentiment periods suggesting that it is driven by investor optimism during high sentiment periods. In contrast Cheon and Lee (2017) find that the MAX premium is stronger following low sentiment periods suggesting that it is driven by the attention‐grabbing characteristic of high MAX stocks in low sentiment periods. We present evidence from China consistent with the MAX premium being driven by investor optimism during high sentiment periods.

Investor sentiment and timely loss recognition

PurposeThe purpose of this paper is to investigate the impact of investor sentiment on timely loss recognition by examining a sample of firms for the period 1988-2015.Design/methodology/approachThe authors use the accruals-based model of Ball and Shivakumar (2005) and a sentiment measure in their primary analysis. Supporting analyses include an extension of Simpson (2013) using an abnormal accruals analysis with subsamples of firms with bad news, the use of a Khan and Watts (2009) quarter firm-level measure of conservatism and an investigation of the monitoring role played by financial analysts.FindingsThe study finds that managers strategically report more losses in high sentiment periods than in low sentiment periods. This loss timing behavior results in an average 37.8 per cent increase in the acceleration of loss recognition. This study additionally finds a negative correlation between investor sentiment and abnormal accruals when managers are reporting bad news, and that a greater number of financial analysts following a firm curtails managers’ acceleration of loss recognition in high sentiment periods.Originality/valueThis study contributes to the corporate disclosure literature by showing that managers strategically recognize losses, and such behavior is more prevalent in high sentiment periods. Managers take advantage of prevailing investor sentiment to accelerate losses in high sentiment periods to mitigate market penalties from reporting bad news.

Differences in options investors’ expectations and the cross-section of stock returns

We provide strong evidence that the dispersion of individual stock options trading volume across moneynesses (IDISP) contains valuable information about future stock returns. Stocks with high IDISP consistently underperform those with low IDISP by more than 1% per month. In line with the idea that IDISP reflects dispersion in investors’ beliefs, we find that the negative IDISP-return relationship is particularly pronounced around earnings announcements, in high sentiment periods and among stocks that exhibit relatively high short-selling impediments. Moreover, the IDISP effect is highly persistent and robustly distinct from the effects of a large array of previously documented cross-sectional return predictors.

The role of online freelance stock analysts in correcting overly pessimistic market sentiment

PurposeThe purpose of this paper is to examine the role of online freelance stock analysts in correcting mispricing of hard-to-value firms during sentiment-driven market periods.Design/methodology/approachThe sample covers 23,758 Seeking Alpha articles obtained for the period between January 2005 and September 2011. The authors use OLS regressions to test the stock market reaction around Seeking Alpha analysts’ reports. The information in online analysts’ reports is measured by the tone of stock articles posted in SeekingAlpha.com (SA).FindingsThe analysis reveals that the degree of negative tone of their stock articles is related to three-day stock returns around the article posting dates. It further reveals that the relation between these returns and prevailing market sentiment depends on firm-specific susceptibility to the market sentiment. The three-day stock returns are higher during low market sentiment periods for firms that are more susceptible to the market sentiment, hence, harder to value. The tone of the stock articles during low sentiment periods also predicts the news in the forthcoming earnings.Practical implicationsThe findings help stock investors identify value-relevant information provided by online freelance stock analysts, particularly for hard-to-value stocks and during the low market sentiment period.Originality/valueThis study utilizes a unique dataset obtained from SA. This is the first paper to examine whether online analysts help investors correct potential undervaluation of hard-to-value firms during the low market sentiment period.

Fund Management Skill and Noise Trading

In this article, the authors show that institutional investors’ skill matters most during high sentiment periods when market signals are noisy. The results reveal that the fund managers with the highest (lowest) skill add (lose) $7.71 ($5.64) million of value during high sentiment periods, compared with a $3.74 million gain realized by the average manager during the entire sample period. When the market sentiment is low, highly skilled fund managers incur a value loss of only $0.18 million, much smaller than the $30.32 million loss realized by their less-skilled counterparts.

Recommendation Pattern Preferences and Share Analysts Bias on the JSE

The trustworthiness of analysts’ reports has rightly been questioned after the financial crises of the 1990s and 2000s revealed biases in their behaviour. This study investigated the inclination of analysts to issue overly-positive recommendations, the issuance patterns preferred by individual analysts, and the differential impact of recommendations between periods of positive and negative sentiment. The recommendation issuance preferences of 901 local and international analysts, who collectively issued 30 486 recommendations for shares listed on the Johannesburg Securities Exchange from 1993 to 2011, were scrutinised. The investigation revealed that analysts issued their opinions using many different patterns within five possible recommendation categories, and showed signs of positive biases during all market cycles and investor sentiment periods. Surprisingly, analysts issued the same proportion of negative recommendations during periods of low business confidence and economic contraction than during phases of growth- and economic upswing. The BER Business Confidence Index outperformed the SARB’s business cycle indicator in demarcating periods where investors reacted stronger to recommendations issued by analysts. Investors are advised to study an analyst’s recommendation history in addition to current advice.

Investor sentiment and price discovery: Evidence from the pricing dynamics between the futures and spot markets

Abstract This study examines the role of investor sentiment in the pricing dynamics between the spot and futures markets. The empirical evidence suggests that investor sentiment has a positive impact on price volatility and the bid–ask spread on both the spot and futures markets, which induces higher arbitrage risk and trading costs during high sentiment periods. Consequently, during high sentiment periods, informed traders become less willing to leverage their information advantages on the futures market, which diminishes the futures markets’ leading informational role and contributions to price discovery. Our findings provide support for the theory of limits to arbitrage.

Institutional Trading, Investor Sentiment and Lottery-Like Stock Preferences

This paper explores the time‐varying institutional investor preference for lottery‐like stocks. On average, institutional investor holdings reflect an aversion to lottery‐like stocks. However, I find that an institutions’ aversion to lottery‐like stocks is reduced when investor sentiment is low. Moreover, I find that during low sentiment periods, institutional investors have abnormally high trading profits in more positively skewed stocks. These results suggest that institutions reduce their aversion toward lottery‐like stocks during low sentiment periods to profitably trade in lottery‐like stocks.

Investor sentiment and the mean-variance relationship: European evidence

This paper investigates the impact of investor sentiment on the mean-variance relationship in 14 European stock markets. Applying three approaches to define investors’ neutrality and determine high and low sentiment periods, we find that individual investors’ increased presence and trading over high-sentiment periods would undermine the risk-return tradeoff. More importantly, we report that investors’ optimism (pessimism) is more determined by their normal sentiment state, represented by the all-period average sentiment level, rather than the neutrality value set in sentiment surveys.