The Information Content of the Sentiment Index

65 Pages Posted: 17 Nov 2012 Last revised: 2 Oct 2015

See all articles by Steven Sibley

Steven Sibley

Kelley School of Business

Yanchu Wang

School of Finance - Shanghai University of Finance and Economics

Yuhang Xing

Rice University

Xiaoyan Zhang

Tsinghua University - PBC School of Finance

Date Written: September 28, 2015

Abstract

The widely-used Baker and Wurgler (2006) sentiment index is strongly correlated with business cycle variables, especially the short interest rate and Lee (2011) liquidity risk factor. The power of the sentiment index to predict cross-sectional stock returns is mainly driven by its information content related to these business cycle variables. About 63% percent of the total variation in the investor sentiment index can be explained by well-known, contemporaneous risk/business cycle variables. We decompose the widely used investor sentiment index into two components: one related to standard risk/business cycle variables and the other unrelated to those variables. We show that the power of the sentiment index to predict cross-sectional stock returns is mainly driven by the risk/business cycle component, while the residual component has little significance in predicting cross-sectional stock returns.

Keywords: investor sentiment index, return predictability, business cycle

JEL Classification: G12

Suggested Citation

Sibley, Steven and Wang, Yanchu and Xing, Yuhang and Zhang, Xiaoyan, The Information Content of the Sentiment Index (September 28, 2015). Available at SSRN: https://ssrn.com/abstract=2176348 or http://dx.doi.org/10.2139/ssrn.2176348

Steven Sibley

Kelley School of Business ( email )

107 S Indiana Ave
100 South Woodlawn
Bloomington, IN 47405
United States

Yanchu Wang

School of Finance - Shanghai University of Finance and Economics ( email )

Shanghai, 200433
China

Yuhang Xing

Rice University ( email )

6100 South Main Street
Houston, TX 7705-1892
United States

Xiaoyan Zhang (Contact Author)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

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