When does investor sentiment predict stock returns?
Journal
Journal of Empirical Finance
Journal Volume
19
Journal Issue
2
Pages
217-240
Date Issued
2012
Author(s)
Abstract
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. ? 2012 Elsevier B.V..
Subjects
Bootstrap
Investor sentiment
Multivariate Markov-switching model
Return predictability
SDGs
Type
journal article