Sentiment Contagion, Corporate Governance, Information and Legal Environments

Abstract

This paper studies impacts of US investor sentiment on non-US stock returns across 38 developed and developing equity markets. Employing data from 1977 to 2004, we find that US sentiment strongly influences future returns for various long-short portfolios designed to reflect sentiment prone stocks. The sentiment contagion is unlikely to be fully explained by the asset holdings of international investors. We find that the sentiment contagion is generally and significantly stronger when the information and legal environments are of high quality. We further document strong evidence that good corporate governance environments help diminish the spread of US investor sentiment across stock markets. Our results also suggest higher correlation for stocks with similar levels of sentiment sensitivity, such as small and high growth stocks, across markets, which will tend to reduce international diversification benefits.

Keywords: Investor Sentiment, Financial Contagion, Information Environment, Legal Environment, Corporate Governance

JEL Classification: G15, G14