Does Sentiment Index Predict Future Returns?

44 Pages Posted: 10 Apr 2017 Last revised: 12 Apr 2017

Muhammad A. Cheema

University of Waikato

Gilbert V. Nartea

University of Waikato

Date Written: April 10, 2017

Abstract

Recent evidence shows that investor sentiment predicts the cross-section of returns and it has larger effects on hard to value and difficult to arbitrage stocks such as high volatility, young, small, unprofitable, and non-dividend paying stocks. Furthermore, the evidence shows that subsequent returns are relatively low (high) for hard to value stocks following high (low) Baker and Wurgler’s (BW) sentiment index suggesting that such stocks are relatively overpriced (underpriced) during high (low) sentiment periods. We present new evidence showing that the prediction of subsequent lower (higher) returns of hard to value stocks following high (low) BW sentiment index occur only when subsequent investor sentiment decreases (increases). In fact, hard to value stocks earn relatively higher (lower) returns following high (low) sentiment periods when the subsequent sentiment increases (decreases).

Keywords: Sentiment changes Index, Sentiment levels index, Sentiment dynamics, Hard to value stocks

JEL Classification: G11, G12, G14

Suggested Citation

Cheema, Muhammad A. and Nartea, Gilbert V., Does Sentiment Index Predict Future Returns? (April 10, 2017). Available at SSRN: https://ssrn.com/abstract=2949772

Muhammad Ahmad Cheema (Contact Author)

University of Waikato ( email )

Te Raupapa
Private Bag 3105
Hamilton, 3240
New Zealand

Gilbert V. Nartea

University of Waikato ( email )

Te Raupapa
Private Bag 3105
Hamilton, 3240
New Zealand

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