Article | Journal of Finance | August 2006

Investor Sentiment and the Cross Section of Stock Returns

by Malcolm Baker and Jeffrey Wurgler


We examine how investor sentiment affects the cross-section of stock returns. Theory predicts that a broad wave of sentiment will disproportionately affect stocks whose valuations are highly subjective and are difficult to arbitrage. We test this prediction by studying how the cross-section of subsequent stock returns varies with proxies for beginning-of-period investor sentiment. When sentiment is low, subsequent returns are relatively high on smaller stocks, high volatility stocks, unprofitable stocks, non-dividend-paying stocks, extreme-growth stocks, and distressed stocks, consistent with an initial underpricing of these stocks. When sentiment is high, on the other hand, these patterns attenuate or fully reverse. The results are consistent with predictions and appear unlikely to reflect an alternative explanation based on compensation for systematic risk.

Keywords: Behavioral Finance; Stocks; Investment Return; Forecasting and Prediction; Motivation and Incentives; Risk and Uncertainty; Volatility;


Baker, Malcolm, and Jeffrey Wurgler. "Investor Sentiment and the Cross Section of Stock Returns." Journal of Finance 61, no. 4 (August 2006): 1645–1680.