On the Predictive Power of Sentiment - Why Institutional Investors are Worth Their Pay

Abstract

We use a unique dataset of private and institutional investors' sentiments to describe their forecasting behavior and to develop a trading strategy based on sentiment. We show that professional analysts are indeed able to forecast future price movements in the medium term (about 6 months in advance). Private investors are not skilled at predicting price movements; we even find evidence that suggests that their sentiment may be a contra indicator. Neither institutional nor private investors can correctly forecast returns a month in advance. It seems that for this kind of short-term prediction, private and institutional investors heavily rely on the past weeks' and months' returns. Applying our trading strategy on out-of-sample data, delivers mixed results. We conclude that institutional investors' sentiment is useful when forecasting returns, especially in respect of their home market.

Keywords: Asset Pricing, Sentiment, Institutional Investors, Private Investors, Investor Behavior, Behavioral Finance

JEL Classification: G1