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The sentiment premium and macroeconomic announcements

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Abstract

Limits to arbitrage imply that market-wide investor sentiment should be a priced factor in the US equity market. While previous studies (Baker and Wurgler in J Financ 61:1645–1680, 2006) focus on the factor loading on market-wide investor sentiment, we study its factor premium in the present paper. This is important, because both factor loadings and premiums are required to estimate expected returns on stocks, which are essential for capital budgeting, portfolio evaluation, investment, and risk analysis decisions. If overpricing is more prevalent than underpricing (Stambaugh et al. in J Financ Econ 104:288–302, 2012), the premium on market-wide investor sentiment should be negative. Furthermore, the sentiment premium should be particularly significant on days without macroeconomic announcements, because there is a lack of information about the state of the economy at such times. We test these hypotheses in this paper, and find supporting evidence. Our findings have important theoretical as well as practical implications.

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Notes

  1. Baek (2016) finds that investor sentiment predicts firm earnings. Examining European options, Chen and Kuo (2014) show that investor sentiment significantly affects interest rate volatility. Szu et al. (2015) find that investor sentiment has a significant impact on call and put option pricing of Taiwan stock index. See also Bird et al. (2014) and Du and Zhao (2017).

  2. For each portfolio formation period, we first calculate average three-year opaque characteristics for each stock; next, we calculate the average characteristics across firms within each portfolio. Lastly, we report time series means of opaque characteristics for each portfolio.

  3. We thank Fama and French for making these data available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/.

  4. See for instance Du (2013) and Du and Hu (2015).

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Authors and Affiliations

  1. The W. A. Franke College of Business, Northern Arizona University, PO Box 15066, Flagstaff, AZ, 86011, USA

    Ding Du

  2. Department of Economics, Youngstown State University, Youngstown, OH, 44555, USA

    Ou Hu

Authors
  1. Ding Du
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  2. Ou Hu
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Correspondence to Ding Du.

Additional information

Part of this research was conducted while Ding Du was visiting the Robert H. Smith School of Business, University of Maryland at College Park. The authors thank the editor Cheng-Few Lee and two anonymous referees for their valuable and insightful comments. The responsibility of any remaining errors is ours.

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Du, D., Hu, O. The sentiment premium and macroeconomic announcements. Rev Quant Finan Acc 50, 207–237 (2018). https://doi.org/10.1007/s11156-017-0628-y

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