Reversal evidence from investor sentiment in international stock markets

Abstract

This research investigates the effect of sentiment on the time-series and cross-section of mean, variance and correlation of asset returns to examine how investor sentiment creates predictable variations in financial markets. Based on the method proposed by Baker and Wurgler (2007, Investor sentiment in the stock market, Journal of Economic Perspectives 21, 129-152), we build composite sentiment indexes with a focus on international markets. Our time-series results show that optimistic (pessimistic) sentiment leads to overpricing (underpricing) and that variance and correlation of asset returns increase when investors are pessimistic. Our cross- section results suggest that these effects tend to become more pronounced for stocks with more exposure to sentiment or the market.