Advertisement

Investor sentiment, investor crowded-trade behavior, and limited arbitrage in the cross section of stock returns

  • Liyun ZhouEmail author
  • Chunpeng Yang
Article
  • 20 Downloads

Abstract

We examine the interaction effects of investor sentiment, investor crowded-trade behavior, and limited arbitrage on the cross section of stock returns. This paper presents strong evidence to reveal that investor crowded-trade behavior will increase stock prices greatly (little) among stocks with positive (negative) investor sentiment; and investor sentiment will increase (not increase) stock prices among stocks with extreme seller-initiated (buyer-initiated) crowded-trade behavior. Furthermore, this paper finds that the benchmark-adjusted returns are positive among stocks with relatively positive investor sentiment and buyer-initiated crowded-trade behavior, and negative among stocks with relatively negative investor sentiment and seller-initiated crowded-trade behavior. Finally, this paper demonstrates that limited arbitrage plays more roles on stocks with pessimistic sentiment and seller-initiated crowded-trade behavior. Taken together, this paper confirms the combined effects of investor sentiment and investor crowded-trade behavior on the cross section of stock returns, and further explores the moderating effect of limited arbitrage.

Keywords

Behavioral finance Investor sentiment Investor crowded-trade behavior Limited arbitrage Stock prices 

Notes

Funding

This study was funded by the Natural Science Foundation of China (71803051; 71471067), the Natural Science Foundation of Guangdong Province (2018A030310218); the project of Guangdong Planning office of Philosophy and Social Science in 2017 (GD17XLJ04; GD17XGL14), the youth project of Department of Education of Guangdong Province (2017WQNCX014), the Natural Science Foundation of China (71720107002).

Compliance with ethical standards

Conflict of interest

No conflict of interest exits in the submission of this manuscript, and manuscript is approved by all authors for publication. Author A declares that she has no conflict of interest. Author B declares that he has no conflict of interest.

Ethical approval

This article does not contain any studies with human participants or animals performed by any of the authors.

References

  1. Akhtar S, Faff R, Oliver B, Subrahmanyam A (2012) Stock salience and the asymmetric market effect of consumer sentiment news. J Bank Finance 36(12):3289–3301CrossRefGoogle Scholar
  2. Ali A, Hwang LS, Trombley MA (2003) Arbitrage risk and the book-to-market anomaly. J Financ Econ 69(2):355–373CrossRefGoogle Scholar
  3. Amihud Y (2002) Illiquidity and stock returns: cross-section and time-series effects. J Financ Mark 5(1):31–56CrossRefGoogle Scholar
  4. Baker M, Stein JC (2004) Market liquidity as a sentiment indicator. J Financ Mark 7(3):271–299CrossRefGoogle Scholar
  5. Baker M, Wurgler J (2006) Investor sentiment and the cross-section of stock returns. J Finance 61(4):1645–1680CrossRefGoogle Scholar
  6. Baker M, Wurgler J (2007) Investor sentiment in the stock market. J Econ Perspect 21(2):129–151CrossRefGoogle Scholar
  7. Baker M, Wurgler J, Yuan Y (2012) Global, local, and contagious investor sentiment. J Financ Econ 104(2):272–287CrossRefGoogle Scholar
  8. Bekaert G, Harvey CR (2000) Foreign speculators and emerging equity markets. J Finance 55(2):565–613CrossRefGoogle Scholar
  9. Blocher J (2016) Network externalities in mutual funds. J Financ Mark 30:1–26CrossRefGoogle Scholar
  10. Canbaş S, Kandır SY (2009) Investor sentiment and stock returns: evidence from Turkey. Emerg Mark Finance Trade 45(4):36–52CrossRefGoogle Scholar
  11. Cao J, Han B (2016) Idiosyncratic risk, costly arbitrage, and the cross-section of stock returns. J Bank Finance 73:1–15CrossRefGoogle Scholar
  12. Carhart MM (1997) On persistence in mutual fund performance. J Finance 52(1):57–82CrossRefGoogle Scholar
  13. Chen H, Chong TTL, Duan X (2010) A principal-component approach to measuring investor sentiment. Quant Finance 10(4):339–347CrossRefGoogle Scholar
  14. Da Z, Engelberg J, Gao P (2015) The sum of all FEARS investor sentiment and asset prices. Rev Financ Stud 28(1):1–32CrossRefGoogle Scholar
  15. Daniel K, Moskowitz TJ (2016) Momentum crashes. J Financ Econ 122(2):221–247CrossRefGoogle Scholar
  16. De Long JB, Shleifer A, Summers LH, Waldmann RJ (1990) Noise trader risk in financial markets. J Polit Econ 98(4):703–738CrossRefGoogle Scholar
  17. DeLisle RJ, McTier BC, Smedema AR (2016) Systematic limited arbitrage and the cross-section of stock returns: evidence from exchange traded funds. J Bank Finance 70:118–136CrossRefGoogle Scholar
  18. Fama EF (1965) The behavior of stock-market prices. J Bus 38(1):34–105CrossRefGoogle Scholar
  19. Gao B, Yang C (2018) Investor trading behavior and sentiment in futures markets. Emerg Mark Finance Trade 54:707–720CrossRefGoogle Scholar
  20. Gomes JF, Kogan L, Zhang L (2003) Equilibrium cross-section of returns. J Polit Econ 111:693–732CrossRefGoogle Scholar
  21. Grundy BD, Martin JSM (2001) Understanding the nature of the risks and the source of the rewards to momentum investing. Rev Financ Stud 14(1):29–78CrossRefGoogle Scholar
  22. Gwilym OA, Hasan I, Wang Q, Xie R (2016) In search of concepts: the effects of speculative demand on stock returns. Eur Financ Manag 22(3):427–449CrossRefGoogle Scholar
  23. Han B, Kong D (2017) Institutional investors and equity prices: information, behavioral bias, and arbitrage. Working paperGoogle Scholar
  24. Han X, Li Y (2017) Can investor sentiment be a momentum time-series predictor? Evidence from China. J Empir Finance 42:212–239CrossRefGoogle Scholar
  25. Hanson SG, Sunderam A (2014) The growth and limits of arbitrage: evidence from short interest. Rev Financ Stud 27(4):1238–1286CrossRefGoogle Scholar
  26. Hong H, Li W, Ni SX, Scheinkman JA, Yan P (2015) Days to cover and stock returns. In: NBER Working Paper SeriesGoogle Scholar
  27. Jia Y, Yang C (2017) Disagreement and the risk-return relation. Econ Model 64:97–104CrossRefGoogle Scholar
  28. Kapadia N, Pu X (2012) Limited arbitrage between equity and credit markets. J Financ Econ 105(3):542–564CrossRefGoogle Scholar
  29. Keynes JM (1936) The general theory of interest, employment and money. Macmillan, LondonGoogle Scholar
  30. Kim T, Ha N (2010) Investor sentiment and market anomalies. In: SSRN Working PaperGoogle Scholar
  31. Kumar A, Lee C (2006) Retail investor sentiment and return comovements. J Finance 61(5):2451–2486CrossRefGoogle Scholar
  32. Kumari J, Mahakud J (2015) Does investor sentiment predict the asset volatility? Evidence from emerging stock market India. J Behav Exp Finance 8:25–39CrossRefGoogle Scholar
  33. Lee EPK (2013) Individual stock investor sentiment, stock issuance, and financial market anomalies. In: SSRN working paperGoogle Scholar
  34. Li J (2015) The asymmetric effects of investor sentiment and monetary policy on stock prices. Appl Econ 47(24):2514–2522CrossRefGoogle Scholar
  35. Li X, Luo D (2016) Investor sentiment, limited arbitrage, and the cash holding effect. Rev Finance 21:2141–2168Google Scholar
  36. Liao TL, Huang CJ, Wu CY (2011) Do fund managers herd to counter investor sentiment? J Bus Res 64(2):207–212CrossRefGoogle Scholar
  37. Lutz C (2016) The asymmetric effects of investor sentiment. Macroecon Dyn 20(6):1477–1503CrossRefGoogle Scholar
  38. Menkveld AJ (2016) Systemic risk in central clearing: should crowded trades be avoided? In: SSRN working paperGoogle Scholar
  39. Morck R, Yeung B, Yu W (2000) The information content of stock markets: why do emerging markets have synchronous stock price movements? J Financ Econ 58(1):215–260CrossRefGoogle Scholar
  40. Ryu D, Kim H, Yang H (2017) Investor sentiment, trading behavior and stock returns. Appl Econ Lett 24(12):826–830CrossRefGoogle Scholar
  41. Shiller RJ (2011) Democratizing and humanizing finance. In: Kroszner RS, Shiller RJ (eds) Reforming US financial markets: reflections before and beyond Dodd-Frank. Alvin Hansen Symposium on Public Policy at Harvard University. MIT press, CambridgeGoogle Scholar
  42. Shiller RJ (2014) Speculative asset prices. Am Econ Rev 104(6):1486CrossRefGoogle Scholar
  43. Sias R, Turtle HJ, Zykaj B (2016) Hedge fund crowds and mispricing. Manage Sci 62(3):764–784CrossRefGoogle Scholar
  44. Stambaugh RF, Yu J, Yuan Y (2012) The short of it: investor sentiment and anomalies. J Financ Econ 104(2):288–302CrossRefGoogle Scholar
  45. Stambaugh RF, Yu J, Yuan Y (2014) The long of it: odds that investor sentiment spuriously predicts anomaly returns. J Financ Econ 114(3):613–619CrossRefGoogle Scholar
  46. Stambaugh RF, Yu J, Yuan Y (2015) Arbitrage asymmetry and the idiosyncratic volatility puzzle. J Finance 70(5):1903–1948CrossRefGoogle Scholar
  47. Stein JC (2009) Presidential address: sophisticated investors and market efficiency. J Finance 64(4):1517–1548CrossRefGoogle Scholar
  48. Wu Y, Liu T, Han L, Yin L (2018) Optimistic bias of analysts’ earnings forecasts: does investor sentiment matter in China? Pac Basin Finance J 49:147–163CrossRefGoogle Scholar
  49. Xu N, Jiang X, Chan KC, Wu S (2017) Analyst herding and stock price crash risk: evidence from China. J Int Financ Manag Account 28(3):308–348CrossRefGoogle Scholar
  50. Yan P (2013) Crowded trades, short covering, and momentum crashes. In: Social science research network, Working paperGoogle Scholar
  51. Yang C, Gao B (2014) The term structure of sentiment effect in stock index futures market. N Am J Econ Finance 30:171–182CrossRefGoogle Scholar
  52. Yang C, Zhou L (2016) Individual stock crowded trades, individual stock investor sentiment and excess returns. N Am J Econ Finance 38:39–53CrossRefGoogle Scholar
  53. Yu J, Yuan Y (2011) Investor sentiment and the mean–variance relation. J Financ Econ 100(2):367–381CrossRefGoogle Scholar
  54. Zhu B, Niu F (2016) Investor sentiment, accounting information and stock price: evidence from China. Pac Basin Finance J 38:125–134CrossRefGoogle Scholar

Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2019

Authors and Affiliations

  1. 1.College of Economics and ManagementSouth China Agricultural UniversityGuangzhouChina
  2. 2.School of Economics and CommerceSouth China University of TechnologyGuangzhouChina

Personalised recommendations