Sentiment and Uncertainty
Fisher College of Business Working Paper No. 2020-03-010
Charles A. Dice Working Paper No. 2020-10
Journal of Financial Economics (JFE), Vol. 146, No. 3, 2022, pages 1148-1169.
97 Pages Posted: 15 May 2020 Last revised: 15 Nov 2022
Date Written: February 25, 2022
Sentiment should exhibit its strongest effects on asset prices at times when valuations are most subjective. Accordingly, we show that a one-standard-deviation increase in aggregate uncertainty amplifies the predictive ability of sentiment for market returns by two to four times relative to when uncertainty is at its mean. For the cross-section of returns, the predictive ability of sentiment for test assets expected to be most sensitive to sentiment, including existing measures of both risk and mispricing, is substantially larger in times of higher uncertainty. The results hold for both daily and monthly proxies for sentiment and for various proxies for uncertainty.
Keywords: sentiment, uncertainty, market return predictability, cross-section of returns, anomalies, mispricing, behavioral finance
JEL Classification: G12, G14, D84
Suggested Citation: Suggested Citation