Investor Sentiment in the Stock Market
Journal of Economic Perspectives, Vol. 21, No. 2, pp. 129-151, Spring 2007
Posted: 30 Apr 2007 Last revised: 12 Jan 2009
Real investors and markets are too complicated to be neatly summarized by a few selected biases and trading frictions. The "top down" approach to behavioral finance focuses on the measurement of reduced form, aggregate sentiment and traces its effects to stock returns. It builds on the two broader and more irrefutable assumptions of behavioral finance - sentiment and the limits to arbitrage - to explain which stocks are likely to be most affected by sentiment. In particular, stocks of low capitalization, younger, unprofitable, high volatility, non-dividend paying, growth companies, or stocks of firms in financial distress, are likely to be disproportionately sensitive to broad waves of investor sentiment. We review the theoretical and empirical evidence for these predictions.
Keywords: sentiment, stocks returns, sentiment index, bubble, crash
JEL Classification: G12, G14, E32
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