Investor Sentiment and Paradigm Shifts in Equity Return Forecasting

forthcoming in Management Science

Posted: 6 Jun 2019 Last revised: 3 Dec 2020

See all articles by Liya Chu

Liya Chu

East China University of Science and Technology (ECUST)

Xuezhong He

University of Technology Sydney (UTS) - Finance Discipline Group, Business School; Financial Research Network (FIRN)

Kai Li

Macquarie Business School, Macquarie University

Jun Tu

Singapore Management University - Lee Kong Chian School of Business

Date Written: May 20, 2019

Abstract

This study investigates the impact of investor sentiment on excess equity return forecasting. A high (low) investor sentiment may weaken the connection between fundamental economic (behavioral-based non-fundamental) predictors and market returns. We find that although fundamental variables can be strong predictors when sentiment is low, they tend to lose their predictive power when investor sentiment is high. Non-fundamental predictors perform well during high-sentiment periods while their predictive ability deteriorates when investor sentiment is low. These paradigm shifts in equity return forecasting provide a key to understanding and resolving the lack of predictive power for both fundamental and non-fundamental variables debated in recent studies.

Keywords: Return predictability, Investors sentiment, Economic predictors, Non-fundamental predictors

JEL Classification: C53, G02, G12, G14, G17

Suggested Citation

Chu, Liya and He, Xue-Zhong 'Tony' and Li, Kai and Tu, Jun, Investor Sentiment and Paradigm Shifts in Equity Return Forecasting (May 20, 2019). forthcoming in Management Science, Available at SSRN: https://ssrn.com/abstract=3391059

Liya Chu (Contact Author)

East China University of Science and Technology (ECUST) ( email )

Shanghai
China

Xue-Zhong 'Tony' He

University of Technology Sydney (UTS) - Finance Discipline Group, Business School ( email )

Haymarket
Sydney, NSW 2007
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Kai Li

Macquarie Business School, Macquarie University ( email )

Level 6 4 Eastern Road, Macquarie University
North Ryde NSW 2109
Sydney, NSW 99999
Australia
435473800 (Phone)

Jun Tu

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
#04-01
Singapore, 178899
Singapore

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