The Real Effects of Investor Sentiment

69 Pages Posted: 30 Nov 2002

See all articles by Christopher Polk

Christopher Polk

London School of Economics

Paola Sapienza

Northwestern University - Kellogg School of Management - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 4 versions of this paper

Date Written: November 2002

Abstract

Does inefficiency of financial markets have real consequences? Or does it only result in transfers of wealth from noise traders to arbitrageurs? We study firm business investment to address this question. In our model, benevolent managers of overvalued companies invest in projects with negative net present value and managers of undervalued companies forego projects with positive net present value. Empirically, we find a positive relation between investment and a number of proxies for mispricing, controlling for investment opportunities and financial slack, suggesting that overpriced (underpriced) firms tend to overinvest (underinvest). Consistent with the predictions of our model, we find that investment is more sensitive to mispricing for firms with higher R&D intensity (suggesting longer periods of information asymmetry) or share turnover (suggesting that the firms' shareholders are short-term investors). We document similar patterns in the cross-section of average returns. Firms with relatively high (low) investment subsequently have relatively low (high) stock returns, after controlling for investment opportunities and other characteristics linked to return predictability. These patterns are stronger for firms with higher R&D intensity or higher share turnover.

Suggested Citation

Polk, Christopher and Sapienza, Paola, The Real Effects of Investor Sentiment (November 2002). AFA 2003 Washington, DC Meetings. Available at SSRN: https://ssrn.com/abstract=354386 or http://dx.doi.org/10.2139/ssrn.354386

Christopher Polk (Contact Author)

London School of Economics ( email )

United Kingdom

HOME PAGE: http://personal.lse.ac.uk/polk/

Paola Sapienza

Northwestern University - Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States
847-491-7436 (Phone)
847-491-5719 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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