Working Paper: NBER ID: w13189
Authors: Malcolm Baker; Jeffrey Wurgler
Abstract: Real investors and markets are too complicated to be neatly summarized by a few selected biases and trading frictions. The "top down" approach to behavioral finance focuses on the measurement of reduced form, aggregate sentiment and traces its effects to stock returns. It builds on the two broader and more irrefutable assumptions of behavioral finance -- sentiment and the limits to arbitrage -- to explain which stocks are likely to be most affected by sentiment. In particular, stocks of low capitalization, younger, unprofitable, high volatility, non-dividend paying, growth companies, or stocks of firms in financial distress, are likely to be disproportionately sensitive to broad waves of investor sentiment. We review the theoretical and empirical evidence for these predictions.
Keywords: No keywords provided
JEL Codes: E32; G11; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| investor sentiment (G41) | stock returns (G12) |
| investor sentiment (G41) | higher valuations for low capitalization, high volatility, and non-dividend paying stocks (G19) |
| investor sentiment (G41) | greater mispricing during high sentiment periods (G41) |
| higher sentiment (E66) | increased returns for speculative stocks (G17) |
| high sentiment (D64) | lower subsequent returns on speculative stocks compared to stable stocks (G17) |