When does investor sentiment predict stock returns?

Chung, S.-L., Hung, C.-H. and Yeh, C.-Y. (2012) When does investor sentiment predict stock returns? Journal of Empirical Finance, 19(2), pp. 217-240. (doi:10.1016/j.jempfin.2012.01.002)

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We examine the asymmetry in the predictive power of investor sentiment in the cross-section of stock returns across economic expansion and recession states. We test the implication of behavioral theories and evidence that the return predictability of sentiment should be most pronounced in an expansion state when investors' optimism increases. We segregate economic states according to the NBER business cycles and further implement a multivariate Markov-switching model to capture the unobservable dynamics of the changes in the economic regime. The evidence suggests that only in the expansion state does sentiment perform both in-sample and out-of-sample predictive power for the returns of portfolio formed on size, book-to-market equity ratio, dividend yield, earnings-to-price ratio, age, return volatility, asset tangibility, growth opportunities, and 11 widely documented anomalies. In a recession state, however, the predictive power of sentiment is generally insignificant.

Item Type:Articles
Glasgow Author(s) Enlighten ID:Hung, Dr Daniel
Authors: Chung, S.-L., Hung, C.-H., and Yeh, C.-Y.
College/School:College of Social Sciences > Adam Smith Business School > Accounting and Finance
Journal Name:Journal of Empirical Finance

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