Value at Risk, Cross-Sectional Returns and the Role of Investor Sentiment, a paper co-authored by our school’s PhD student Bi Jia under the Tilburg Program, and Assistant Professor Zhu Yifeng, was officially accepted by Journal of Empirical Finance, a prestigious international journal on finance. Credit was also given to our school’s Professor Ying Zhanyu and Professor Frans de Roon from the TIAS School for Business and Society, Tilburg University, for their guidance. The paper provides a new perspective on looking at the relationship between risks and cross-sectional expected returns, and finds that at different investor sentiment levels, value-at-risk (VaR) shows completely different prediction capabilities for cross-sectional expected returns. It has hence made important academic contributions to researches on empirical asset pricing and behavioral finance, among others.

By analyzing data about listed companies in the US stock market over a period of more than 50 years, this paper finds that VaR has a negative relationship with cross-sectional expected returns on stocks, and such relationship can be explained by volatility of the US market. By observing different periods of the US stock market based on investor sentiment, it finds that VaR is negatively correlated with cross-sectional expected returns during a high investor sentiment period, which cannot be explained by momentum, short-term reversal, volatility or financial distress. But in a low investor sentiment period, there was no obvious correlation between the two. These empirical results support the prospect theory, which holds that when fully confident, investors will show their risk preferences and are willing to hold high-risk assets. Such a negative relationship is shown more intensively in stocks where individual investors account for a high percentage.

The main contribution made by the paper is that by using investor sentiment as a key indicator to measure different subject matters, and dividing overall data into two categories - high and low investor sentiments, it finds that the relationship between VaR and cross-sectional expected returns performs completely differently at different investor sentiment levels. This finding offers some important lessons to both academic circles and the industry, fills a small gap in the area of empirical financial research, and provides a broader way of thinking on the integrated development of psychology and finance.