Investor Sentiment, Anomaly, and the Macroeconomy

This paper examines whether the results supporting a sentiment-related overpricing story is valid even after controlling for the effect of macroeconomic conditions. We no longer find the results consistent with the sentiment-related overpricing story after adjusting for the effect of several macroeconomic variables. Further, we find that the risk factors associated with macroeconomic variables are mostly priced and that a large portion of the average return spread in the anomalies is accounted for by their expected return spread implied by the risk factors. Thus, a substantial amount of the explanatory power of investor sentiment for the anomalies is attributed to investor sentiment co-varying with the risk premiums of those factors. We thus argue that the anomalies are not necessarily attributed to sentiment-related overpricing, but rather to macroeconomic conditions.