Sentiment, Loss Firms, and Investor Expectations of Future Earnings
50 Pages Posted: 25 Sep 2017
Date Written: September 22, 2017
This study investigates the mispricing of market-wide investor sentiment by exploring the relation between sentiment and investor expectations of future earnings. We predict and find that investors perceive losses to be more (less) persistent during periods of low (high) sentiment. We find similar (albeit weaker) evidence that investor perception of profit persistence is attenuated (enhanced) during periods of low (high) sentiment. This is consistent with prior research, which suggests that sentiment-driven mispricing should be most pronounced for hard-to-value firms—such as those reporting losses (Baker and Wurgler 2006). We also document predictable cross-sectional variation in the mispricing of loss firms: the mispricing of such firms is mitigated for losses associated with activities expected to generate future benefits (such as R&D, growth, and curtailments). Overall, our results add to prior literature by documenting a new and important channel—investor expectations of future earnings—to explain sentiment-driven mispricing.
Keywords: investor sentiment, mispricing, earnings persistence, losses
JEL Classification: D21, G02, G11, M41
Suggested Citation: Suggested Citation