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Investor Sentiment and Economic Forces

46 Pages Posted: 25 Jan 2012 Last revised: 18 Jul 2016

Junyan Shen

University of Minnesota - Twin Cities

Jianfeng Yu

Tsinghua University - PBC School of Finance

Shen Zhao

Chinese university of Hong Kong (Shenzhen)

Date Written: July 18, 2016

Abstract

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.

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

JEL Classification: G02, G12, G14

Suggested Citation

Shen, Junyan and Yu, Jianfeng and Zhao, Shen, Investor Sentiment and Economic Forces (July 18, 2016). Available at SSRN: https://ssrn.com/abstract=1991244 or http://dx.doi.org/10.2139/ssrn.1991244

Junyan Shen

University of Minnesota - Twin Cities ( email )

420 Delaware St. SE
Minneapolis, MN 55455
United States

Jianfeng Yu (Contact Author)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

Shen Zhao

Chinese university of Hong Kong (Shenzhen) ( email )

2001 Longxiang Road,
Longgang District,
Shenzhen
China

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