Investor Sentiment, Beta, and the Cost of Equity Capital

Management Science, Forthcoming

49 Pages Posted: 7 Jul 2012 Last revised: 26 Dec 2019

See all articles by Constantinos Antoniou

Constantinos Antoniou

University of Warwick - Warwick Business School

John A. Doukas

Old Dominion University - Strome College of Business

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Date Written: September 23, 2014

Abstract

The security market line (SML) accords with the capital asset pricing model (CAPM) by taking on an upward slope in pessimistic sentiment periods, but is downward sloping during optimistic periods. We hypothesize that this finding obtains because periods of optimism attract equity investment by unsophisticated, overconfident, traders in risky opportunities (high beta stocks), while such traders stay along the sidelines during pessimistic periods. Thus, high beta stocks become overpriced in optimistic periods, but during pessimistic periods, noise trading is reduced, so that traditional beta pricing prevails. Unconditional on sentiment, these effects offset each other. While rational explanations cannot completely be ruled out, analyses using earnings expectations, fund flows, the probability of informed trading, and order imbalances do provide evidence that noise traders are more bullish about high beta stocks when sentiment is optimistic, while investor behavior appears to accord more closely with rationality during pessimistic periods, supporting our hypothesis.

Keywords: CAPM, Sentiment, Overconfidence.

JEL Classification: G12, G14

Suggested Citation

Antoniou, Constantinos and Doukas, John A. and Subrahmanyam, Avanidhar, Investor Sentiment, Beta, and the Cost of Equity Capital (September 23, 2014). Management Science, Forthcoming , Available at SSRN: https://ssrn.com/abstract=2101724 or http://dx.doi.org/10.2139/ssrn.2101724

Constantinos Antoniou

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

John A. Doukas

Old Dominion University - Strome College of Business ( email )

2080 Constant Hall
Suite 2080
Norfolk, VA 23529-0222
United States
757-683-5521 (Phone)

HOME PAGE: http://www.efmaefm.org/0DOUKAS/doukas.php

Avanidhar Subrahmanyam (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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