We extend the theory and empirics in Chen, Hong, and Stein (2002) by assuming that investors subject to market sentiment hold a biased belief in the aggregate. With a dynamic multi-asset model, we predict that the breadth-return relationship can be either positive or negative depending on the relative strength of two offsetting forces — disagreement and sentiment. Using the sentiment index developed in Baker and Wurgler (2006, 2007), we find evidence consistent with our predictions. The breadth-return relationship is positive when the sentiment effect is small. However, the relationship becomes negative when (i) the time-series variation of market-wide sentiment is high and (ii) the cross-sectional dispersion of firm-specific exposure to market-wide sentiment variation is large. Our unified framework reconciles a few seemingly inconsistent empirical studies in this literature and explains puzzling cross-sectional return patterns observed during the Internet bubble and the subprime crisis periods.
Investor sentiment, disagreement, breadth of ownership, cross-sectional stock returns
Accounting | Marketing
Financial Performance Analysis
INFORMS (Institute for Operations Research and Management Sciences)
LU, Hai; CEN, Ling; and YANG, Liyan.
Investor sentiment, disagreement, and the breadth return relationship. (2012). Management Science. 59, (5), 1076-1091. Research Collection School Of Accountancy.
Available at: http://ink.library.smu.edu.sg/soa_research/1597
Creative Commons License
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.