IINVESTOR SENTIMENT EFFECTS ON STOCK RETURNS AN EMPIRICAL STUDY

Abstract

This paper investigates investor sentiment (non-market based) effects on aggregate stock returns in short time horizon (1 month). Using five market return proxies (Dow Jones Industrial Average monthly return, S&P 500 monthly return, Russell 300 monthly return, NYSE and NASDAQ value/equal-weight monthly return), the empirical results address the first hypothesis in this paper. There is evidence to establish a positive correlation between change in investor sentiment and aggregate stock returns. This suggests that when there is an increase in investor sentiment, aggregate stocks have contemporaneously higher returns. When there is a decrease in investor sentiment, aggregate stocks have contemporaneously lower returns. Beyond the analysis of aggregate stock return, this paper also examines the sentiment (non-market based) sensitivity of cross sectional stock returns in short time horizon (1 month). Stocks are sorted into ten different deciles according to size and bookto-market. The empirical findings address the second hypothesis in this paper. There is evidence to support that smaller size stock returns are more sensitive to investor sentiment. When there is an increase in sentiment, smaller size stocks have contemporaneously higher returns relative to bigger stocks. When there is a decrease in sentiment, smaller size stocks have contemporaneously lower returns relative to bigger stocks. The results for stocks that are sorted according book-to-market are not as straight forward. There is a U-shape sentiment trend line that suggests that both high and low book-to-market stocks are sensitive to market sentiment.