Investor Sentiment and Paradigm Shifts in Equity Return Forecasting

Liya Chu (), Xuezhong (Tony) He, Kai Li and Jun Tu ()
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Liya Chu: East China University of Science and Technology, Shanghai 200231, China
Jun Tu: Singapore Management University, Singapore, Singapore 188065

Management Science, 2022, vol. 68, issue 6, 4301-4325

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 nonfundamental) 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. Nonfundamental 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 nonfundamental variables debated in recent studies.

Keywords: return predictability; economic predictors; non-fundamental predictors; regime-switching; behavioral biases (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:68:y:2022:i:6:p:4301-4325

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