Sentiment Strategy

Abstract

This study tests if investor’s sentiment risk is valued by the stock markets. We form portfolios based upon the stock returns’ exposure to sentiment. Our results show that, globally, the stocks most influenced by the sentiment factor earn higher returns than the stocks less impacted by the sentiment factor. The strategy consisting of buying portfolios of stocks with greater exposure to sentiment and selling those with the lower exposure generates a statistically significant raw profit. Exploring the sources of profit, we find that neither the traditional risk factors nor the momentum factor (conventional risk) can account for the profit. However, the addition of the sentiment risk premium contributes to better explain the profit.

Keywords: Investor sentiment, Stock returns, Noise trader risk.