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  • August 2006
  • Article
  • Journal of Finance

Investor Sentiment and the Cross Section of Stock Returns

By: Malcolm Baker and Jeffrey Wurgler
  • Format:Print
  • | Pages:36
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Abstract

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

Citation

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

Malcolm P. Baker

Finance
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  • Leverage and the Beta Anomaly By: Malcolm Baker, Mathias F. Hoeyer and Jeffrey Wurgler
  • Financing the Response to Climate Change: The Pricing and Ownership of U.S. Green Bonds By: Malcolm Baker, Daniel Bergstresser, George Serafeim and Jeffrey Wurgler
  • Detecting Anomalies: The Relevance and Power of Standard Asset Pricing Tests By: Malcolm Baker, Patrick Luo and Ryan Taliaferro
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