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Investor Sentiment and Economic Forces

Junyan Shen

University of Minnesota - Twin Cities

Jianfeng Yu

University of Minnesota

December 1, 2013

This study explores the role of investor sentiment in the pricing of a broad set of macro-related risk factors. Economic theory suggests that pervasive factors (such as TFP and consumption growth) should be priced in the cross-section of stock returns. However, when we form portfolios based directly on their exposure to macro factors, we find that portfolios with higher risk exposure do not earn higher returns. More important, we discover a striking two-regime pattern for all 10 macro-related factors: high-risk portfolios earn significantly higher returns than low-risk portfolios following low-sentiment periods, whereas the exact opposite occurs following high-sentiment periods. We argue that these findings are consistent with a setting in which market-wide sentiment is combined with short-sale impediments and sentiment-driven investors undermine the traditional risk-return tradeoff, especially during high-sentiment periods.

Number of Pages in PDF File: 46

Keywords: macro risk, factor, investor sentiment, beta, factor-mimicking portfolio

JEL Classification: G02, G12, G14

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Date posted: January 25, 2012 ; Last revised: December 2, 2013

Suggested Citation

Shen, Junyan and Yu, Jianfeng, Investor Sentiment and Economic Forces (December 1, 2013). Available at SSRN: http://ssrn.com/abstract=1991244 or http://dx.doi.org/10.2139/ssrn.1991244

Contact Information

Junyan Shen
University of Minnesota - Twin Cities ( email )
420 Delaware St. SE
Minneapolis, MN 55455
United States
Jianfeng Yu (Contact Author)
University of Minnesota ( email )
321 19th Avenue
Suite 3-122
Minneapolis, MN 55455
United States
HOME PAGE: http://users.cla.umn.edu/~jianfeng/
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