Investor Sentiment, Style Investing, and Momentum

Abstract

Investor sentiment is an important condition for style investing in affecting asset price predictability. We find that style returns have predictive power for future stock returns in high sentiment periods, but not low sentiment periods. The correlation between style returns and stock returns explains the variation in momentum profits in high sentiment periods, but not low sentiment periods. Sentiment has an interaction effect with style returns, but not market returns. While positive style returns predict future stock returns under high sentiment, negative style returns do not. The effect of investor sentiment on style investing is independent of prior market returns.

Keywords: Investor sentiment, Style investing, Comovement, Momentum, Return predictability, Behavioral finance

JEL Classification: G11, G12, G14, D03