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【Fuwei JIANG】Investor Sentiment Aligned: A Powerful Predictor of Stock Returns

Published:2019-07-01  Views:


The title of the paper:  


“Investor Sentiment Aligned: A Powerful Predictor of Stock Returns”, Review of Financial Studies 28, 2015, 791–837  



The influence of the paper:  


This paper was selected by ESI as the Top Papers and Highly Cited Papers in 2016-2019; as well as the Most Read Papers and Highly Cited Papers in 2015-2016 by the official website of the Review of Financial Studies. It was also reprinted by media websites such as SSCI, CFADigest, Alpha Architect, ValueWalk, Economic and Financial Network.  



Abstract: In this paper, we propose a new sentiment index constructed with the purpose of predicting the aggregate stock market. In contrast with the widely used Baker and Wurgler (2006) sentiment index, our aligned index eliminates the common noise com-ponent of multiple sentiment proxies. Empirically, we find that our index has greater power in predicting the aggregate stock market than the Baker and Wurgler (2006) index: it increases the predictive R²s by more than five times both in-sample and out-of-sample, and outperforms any of the well recognized macroeconomic variables. The predictability is both statistically and economically significant. Moreover, our new index improves substantially the forecasting power too for the cross-sectional stock returns formed on industry, size, value, and momentum. Finally, consistent with Baker and Wurgler (2007), we show that the driving force of the predictive power of investor sentiment stems from investors' biased belief about future cash flows.



JEL classifications: C53, Gl1, G12, G17  



Keywords: Investor Sentiment, Asset Pricing, Return Predictability, Cash Flow  


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