Is sentiment the solution to the risk–return puzzle? A (cautionary) note

Ung, S.N., Gebka, B. and Anderson, R.D., 2023. Is sentiment the solution to the risk–return puzzle? A (cautionary) note. Journal of Behavioral and Experimental Finance, 37, p.100787.

Posted: 5 Jul 2023

See all articles by Sze Nie Ung

Sze Nie Ung

Alliance Manchester Business School

Bartosz Gebka

Newcastle University Business School

Robert Anderson

University of Newcastle - Economics

Date Written: March 1, 2023

Abstract

The risk–return relationship in stock markets is often found to be negative or non-existent, in contrast with fundamental finance theories. In this note we investigate if one proposed solution to this puzzle, which states that high irrational investor sentiment disrupts the otherwise positive risk–return nexus, is robust across popular sentiment proxies and therefore empirically comprehensively validated. We find that it is not robust, as most individual sentiment proxies fail to support the hypothesised negative impact of sentiment on the risk–return relationship. Only when a common component of individual proxies is extracted to form a single sentiment measure do we find robust support for the notion that high sentiment impedes rational asset pricing.

Keywords: Risk–return trade-off; Investor sentiment; Market returns; Volatility risk

JEL Classification: G10; G40

Suggested Citation

Ung, Sze Nie and Gebka, Bartosz and Anderson, Robert, Is sentiment the solution to the risk–return puzzle? A (cautionary) note (March 1, 2023). Ung, S.N., Gebka, B. and Anderson, R.D., 2023. Is sentiment the solution to the risk–return puzzle? A (cautionary) note. Journal of Behavioral and Experimental Finance, 37, p.100787., Available at SSRN: https://ssrn.com/abstract=4501021

Sze Nie Ung (Contact Author)

Alliance Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Bartosz Gebka

Newcastle University Business School ( email )

5 Barrack Road
Newcastle, Tyne and Wear NE1 4SE
United Kingdom
+44 191 208 1578 (Phone)

HOME PAGE: http://https://www.ncl.ac.uk/business-school/staff/profile/bartoszgebka.html#background

Robert Anderson

University of Newcastle - Economics ( email )

5 Barrack Road
Newcastle, Tyne and Wear NE1 4SE
United Kingdom
+441912081667 (Phone)

HOME PAGE: http://www.ncl.ac.uk/business/people/profile/robertanderson.html

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