Investor Sentiment Aligned: A Powerful Predictor of Stock Returns
Review of Financial Studies 28, 791-837, 2015
67 Pages Posted: 19 Aug 2013 Last revised: 30 Jan 2019
Date Written: October 13, 2014
We propose a new investor sentiment index that is aligned with the purpose of predicting the aggregate stock market. By eliminating a common noise component in sentiment proxies, the new index has much greater predictive power than existing sentiment indices both in- and out-of-sample, and the predictability becomes both statistically and economically significant. In addition, it outperforms well recognized macroeconomic variables and can also predict cross-sectional stock returns sorted by industry, size, value, and momentum. The driving force of the predictive power appears stemming from investors’ biased belief about future cash flows.
Keywords: Investor Sentiment, Asset Pricing, Return Predictability, Cash Flow, Discount Rate
JEL Classification: C53, G11, G12, G17
Suggested Citation: Suggested Citation