Investor Emotions and Asset Prices

Abstract

We develop a new emotion-based market-level sentiment indicator to measure the emotional state of the market. Using this aggregate series, we compute firm-level sensitivity to shifts in market-level emotions and find that stocks with high-emotion betas outperform low-emotion beta firms. This performance differential is corrected in about six months. A trading strategy that takes a Long (Short) position in high-(low-) emotion beta stocks generates an annualized alpha of over 6%. This evidence of emotion-based predictability is distinct from the known pricing effects of mood, traditional sentiment measures, economic and policy uncertainty, and tone.

Keywords: Investor emotions, market emotion index, emotion beta, investor sentiment, return predictability JEL classification: G12

JEL Classification: G12, G14