Investor Sentiment, Cross-sectional Stock Returns, and Short-Sales: Evidence From Korea

Purpose: This study investigates the return co-movements associated with investor sentiment shifts in the cross-sections under a setting where market-wide sentiment interacts with short-sale impediments. Design/methodology/approach: This study estimates the return sensitivity to market sentiment changes (sentiment beta) for each characteristic's portfolio by regressing the return of each quintile portfolio and various high-minus-low portfolios on the sentiment changes index. It examines whether these cross-sectionally different return co-movement patterns is more prevalent during good- than bad-sentiment periods by performing the same regression separately for the good- and bad-sentiment periods. Findings: The result shows that the returns of speculative stocks tend to co-move more strongly with sentiment changes than those of stable stocks, in the sense that speculative stocks have higher sentiment betas than stable stocks. The cross-sectional pattern in return co-movements becomes more pronounced during the good-sentiment period but disappears during the bad-sentiment periods. Research limitations/implications: This study elucidates the return co-movement behavior associated with investor sentiment changes under a setting where market-wide sentiment interacts with short-sale impediments. However, analyzing the relationship between the investment sentiment index and the short-selling activities is reserved for future research. Originality/value: The results provide important implications for investment strategies using investor sentiment in practice, and several suggestions for establishing investor protection policies in the highly individual-crowded market. This study will contribute to enhancing the stock market efficiency and price discovery.