Investor Sentiment: Predicting the Overvalued Stock Market
10 Pages Posted: 2 Apr 2018 Last revised: 18 May 2020
Date Written: May 15, 2020
The research literature shows that investor sentiment is a contrarian predictor of aggregate stock market returns. However, we contend that investor sentiment only predicts aggregate stock market returns during high-sentiment states where overpricing is more prevalent than underpricing. Using a two-state predictive regression model, we find that the investor sentiment indexes of both Baker and Wurgler (2006) and Huang et al. (2014) are contrarian predictors of aggregate stock market returns at all horizons during high-sentiment states, which agrees with our hypothesis.
Keywords: Investor Sentiment, Overpricing, Underpricing, Stock Market Returns
JEL Classification: C53, G11, G12, G17
Suggested Citation: Suggested Citation