Sentiment Metrics and Investor Demand

Abstract

Recent work suggests that sentiment traders shift from safer to more speculative stocks when sentiment increases. Exploiting these cross-sectional patterns and changes in share ownership, we find that sentiment metrics capture institutional rather than individual investors' demand shocks. We investigate the underlying economic mechanisms and find that common institutional investment styles (e.g., risk management, momentum trading) explain a significant portion of the relation between institutions and sentiment. THE INVESTOR SENTIMENT LITERATURE TYPICALLY assumes that irrational individual investors are the source of sentiment-based demand shocks that drive prices from value. For instance, the earliest academic article focusing on this issue uses odd-lot trading to identify demand shocks attributed to "public psychology" relative to the more rational views of "New York Stock Exchange members" (Drew et al. (1950)). The assumption that individual investors are responsible for sentiment-induced mispricing has been explicitly repeated in the nearly 70 years that have followed. 1 In fact, many of the traditional proxies for * Luke DeVault is with Clemson University. Richard Sias is with the Eller College of Management, the University of Arizona. Laura Starks is with the McCombs School of Business, University of Texas at Austin. We thank seminar participants at

Institutional investor sentiment, beta, and stock returns

“…Thus, β 1 , β 1 + β 2 , and β 1 + β 3 are the beta-return relations over neutral, bullish, and bearish periods, accordingly. As hypothesized, in the context that institutional investors are sentiment traders (DeVault et al, 2019), their elevated trading over bullish periods tends to distort the positive beta-return relation, leading β 1 + β 2 not to be significantly positive, while the risk-return tradeoff should be discovered over bearish periods, i.e., a significantly positive β 1 + β 3 . Table 4 presents the heterogeneity in the beta-return relation across different institutional investor sentiment regimes.…”

“…In one recent paper, DeVault et al (2019) uncover that in contrast to theoretical models that institutional investors are free from irrational trading, they, rather than individual investors, are more likely to be sentiment traders driving the sentiment-induced mispricing, due to common institutional investment styles such as risk management, reputational concerns, momentum trading, and herding. Applying this argument into the context of the mean-variance relation, Wang (2018b) document that institutional investors' higher participation over the optimistic periods would distort the positive mean-variance relation exhibited over the pessimistic periods, confirming that institutional investors can also be sentiment traders (for global evidence, see, .…”

“…To this end, we investigate the role of institutional investor sentiment in determination of the beta-return relation. We hypothesize that if institutional investors are sentiment traders as suggested by DeVault et al (2019), the risk-return tradeoff would be undermined when they are bullish while would be observed when they are bearish. In other words, an upward-sloping (downward-sloping) SML could be revealed over bearish (bullish) periods.…”

Do Overnight Returns Truly Measure Firm-Specific Investor Sentiment in the KOSPI Market?

“…As a result, the field of behavioral finance has emerged. Behavioral finance studies, which examine investors' overreactions, underreactions, disposition effects, noise trading, herding phenomena, moods, and sentiments, empirically analyze both developed (Branch and Evans, 2010 [1]; Devault, Sias, and Starks, 2019 [2]; Kothari, Lewellen, and Warner, 2006 [3]) and emerging (Ryu, 2013 [4]; Shim, Kim, Kim, and Ryu, 2015 [5]; Shim, Kim, and Ryu, 2017 [6]; Yang, Ahn, Kim, and Ryu, 2017 [7]) markets.…”

Investor Sentiment and Employment

“…This seems less likely, however, forBaker and Wurgler's (2006) measure of investor sentiment, especially in light of the negative sentiment beta for low-volatility stocks (seeDeVault, Sias, and Starks (2019) for an excellent discussion).14 For brevity, we report only the coefficients of interest.…”