Sentiment and the cross-section of expected stock returns

The asset pricing Literature suggests market sentiment is a state variable. This study shows that market sentiment is positively priced at the cross-section of stock returns, conditional on aggregate investors’ sentiment. We estimate individual stock sentiment beta and find that, following low-sentiment periods, stocks in the highest sentiment beta quintile generate a 0.74% higher monthly return than stocks in the lowest sentiment beta quintile. However, this return spread is insignificant following medium- or high-sentiment periods. This finding is consistent with the argument that overpricing following high-sentiment periods is more prevalent than underpricing following low-sentiment periods due to short-sale constraints.