The short of it: Investor sentiment and anomalies
Robert F. Stambaugh, Jianfeng Yu, and Yu Yuan
November 3, 2011
This study explores the role of investor sentiment in a broad set of anomalies in cross-sectional stock returns. We consider a setting in which the presence of marketwide sentiment is combined with the argument that overpricing should be more prevalent than underpricing, due to short-sale impediments. Long-short strategies that exploit the anomalies exhibit proﬁts consistent with this setting. First, each anomaly is stronger (its long-short strategy is more proﬁtable) following high levels of sentiment. Second, the short leg of each strategy is more proﬁtable following high sentiment. Finally, sentiment exhibits no relation to returns on the long legs of the strategies.
JEL classiﬁcations: G12, G14
Keywords: investor sentiment, anomalies
* We are grateful for helpful comments from Scott Cederburg, Zhi Da, Kent Daniel, Wayne Ferson, ˇ
Murray Frank, Byoung-Hyoun Hwang, Paul Irvine, Robert Novy-Marx, Stavros Panageas, Luboˇ P´stor, s a
Bill Schwert, Jeﬀ Wurgler, Jinghua Yan, seminar participants at Fudan University, Shanghai Advanced Institute of Finance (SAIF), the University of Arizona, the University of Minnesota, and the University of Pennsylvania, and participants at the 2010 Conference on Financial Economics and Accounting, the 2011 China International Conference in Finance, the 2011 Driehaus Behavioral Finance Symposium, the 2011 George Washington University–International Monetary Fund Conference on Behavioral Finance, and the 2011 National Bureau of Economic Research Behavioral Finance Meeting. We also thank Edmund Lee and Huijun Wang for excellent research assistance. Jianfeng Yu gratefully acknowledges ﬁnancial support from the Dean’s Small Research Grant from the Carlson School of Management at the University of Minnesota. Stambaugh: Miller, Anderson & Sherrerd Professor of Finance, The Wharton School, University of Pennsylvania, Philadelphia, PA 19104 and NBER, phone 215-898-5734, email firstname.lastname@example.org. Yu: Assistant Professor of Finance, The Carlson School of Management, University of Minnesota, 321 19th Avenue South, Suite 3-122, Minneapolis, MN 55455, phone 612-625-5498, email email@example.com. Yuan: Visiting Assistant Professor, The Wharton School, University of Pennsylvania, 3620 Locust Walk Suite 2300, Philadelphia, PA 19104, phone 215-898-2370, email firstname.lastname@example.org.
Electronic copy available at: http://ssrn.com/abstract=1567616
Whether investor sentiment aﬀects stock prices is a question of long-standing interest
to economists. At least as early as Keynes (1936), numerous authors have considered the possibility that a signiﬁcant presence of sentiment-driven investors can cause prices to depart from fundamental values. The classic argument against sentiment eﬀects is that they would be eliminated by rational traders seeking to exploit the proﬁt opportunities created by mispricing. If rational traders cannot fully exploit such opportunities, however, then sentiment eﬀects become more likely.
This study investigates the presence of sentiment eﬀects by combining two concepts that are prominent, separately, in the related literature. The ﬁrst concept is that investor sentiment contains a market-wide component with the potential to inﬂuence prices on many securities in the same direction at the same time.1 The second concept, which traces to Miller (1977), is that impediments to short selling play a signiﬁcant role in limiting the ability of rational traders to exploit overpricing.2 As Miller argues (p. 1154): A market with a large number of well informed investors may not have any grossly undervalued securities, but if those investors are unwilling to sell short (as they often are) their presence is consistent with a few investments being overvalued. Combining Miller’s argument with the presence of market-wide sentiment...
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