Market Sentiment and the Cross-section of Expected Stock Returns
55 Pages Posted: 10 Feb 2020 Last revised: 12 Sep 2022
Date Written: September 11, 2022
Kozak, Nagel, and Santosh (2018) present a theory that suggests market sentiment is a state variable. This study presents evidence that market sentiment is positively priced in the cross-section of stock returns, conditional on aggregate investor sentiment levels. We estimate individual stock exposure to market sentiment and find that, following periods of low market sentiment, stocks in the highest sentiment beta quintile generate a 0.74% higher ex-post monthly return than stocks in the lowest sentiment beta quintile. However, this return spread is not significant following medium- or high-sentiment periods. This finding is consistent with the argument that overpricing following high-sentiment periods is more prevalent than underpricing following low-sentiment periods due to short-sale constraints.
Keywords: Sentiment Risk, Sentiment Beta, Stock Returns, Short-sale Constraints
JEL Classification: G12, G41
Suggested Citation: Suggested Citation