Sentiment and Uncertainty

Fisher College of Business Working Paper No. 2020-03-010

Charles A. Dice Working Paper No. 2020-10

71 Pages Posted: 15 May 2020

See all articles by Justin Birru

Justin Birru

Ohio State University (OSU) - Department of Finance

Trevor Young

London Business School - Department of Finance

Date Written: May 15, 2020

Abstract

Sentiment should exhibit its strongest effects on asset prices at times when valuations are most subjective. Consistent with this hypothesis, 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. We find similar evidence for the cross-section of returns; the predictive ability of sentiment for returns of test assets expected to be most sensitive to sentiment and for anomaly returns 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. The evidence sheds light on one component of time-series variation in mispricing and suggests that the effects of sentiment are greatest in times of higher uncertainty.

Keywords: sentiment, uncertainty, market return predictability, cross-section of returns, anomalies, mispricing, behavioral finance

JEL Classification: G12, G14, D84

Suggested Citation

Birru, Justin and Young, Trevor, Sentiment and Uncertainty (May 15, 2020). Fisher College of Business Working Paper No. 2020-03-010, Charles A. Dice Working Paper No. 2020-10, Available at SSRN: https://ssrn.com/abstract=3601933 or http://dx.doi.org/10.2139/ssrn.3601933

Justin Birru (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

Trevor Young

London Business School - Department of Finance ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

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