Investor Sentiment and the (Discretionary) Accrual-Return Relation

27 Pages Posted: 28 Sep 2020

See all articles by Jiajun Jiang

Jiajun Jiang

Fudan University - School of Economics

Qi Liu

Peking University - Department of Finance

Bo Sun

Board of Governors of the Federal Reserve System

Date Written: September, 2020

Abstract

Discretionary accruals are positively associated with stock returns at the aggregate level but negatively so in the cross section. Using Baker-Wurgler investor sentiment index, we find that a significant presence of sentiment-driven investors is important in accounting for both patterns. We document that the aggregate relation is only prominent during periods of high investor sentiment. Similarly, the cross-section relation is considerably stronger in high-sentiment periods in both economic magnitude and statistical significance. We then embed investor sentiment into a stylized model of earnings management, and illustrate that a positive (negative) relationship between stock returns and earnings management can endogenously emerge in the aggregate (cross section). Our analysis suggests that the (discretionary) accrual-return relation at both the aggregate and firm levels at least partially reflects mispricing that is related to market-wide investor sentiment.

Keywords: Investor sentiment, Uncertainty, Earnings management, Accrual anomaly

JEL Classification: D82, D83, G12, G14

Suggested Citation

Jiang, Jiajun and Liu, Qi and Sun, Bo, Investor Sentiment and the (Discretionary) Accrual-Return Relation (September, 2020). FRB International Finance Discussion Paper No. 1300, Available at SSRN: https://ssrn.com/abstract=3699469 or http://dx.doi.org/10.17016/IFDP.2020.1300

Jiajun Jiang (Contact Author)

Fudan University - School of Economics ( email )

600 GuoQuan Road
Shanghai, 200433
China

Qi Liu

Peking University - Department of Finance ( email )

Beijing
China

Bo Sun

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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