32 Pages Posted: 3 Sep 2004
Date Written: August 20, 2004
This paper documents the profitability of the sentiment strategies. Using the aggregate closed-end fund discount as a proxy for investor sentiment, we construct a simple sentiment strategy on the basis of the exposure of stock returns to the closed-end fund discount. The sentiment strategies buy stocks with highest exposure to closed-end fund discount and sell stocks with lowest exposure to closed-end fund discount in the past 36 months. We show that such a strategy can lead to an annualized profit of 11 percent. We also explore the source of the profitability and find that neither market risk nor momentum anomaly can account for the profitability. However, the traditional 4-factor asset pricing model when augmented with an additional sentiment factor can account for the profit. We interpret this finding as supportive evidence that the pricing of the investor sentiment risk may be a potentially useful explanation for the profitability.
Keywords: Sentiment strategy, profitability, investor sentiment, risk factor
JEL Classification: G11, G12, C31
Suggested Citation: Suggested Citation