Research On The Relationships Between Investor Sentiment And Cross-Sectional Stock Returns In U.S. Markets

Investor sentiment is considered to be an ideal proxy measuring the stock return of irrational factors on the current literature. The results reported by Baker and Wurgler (2006) find that the relationship between investor sentiment and future cross-sectional stock returns is negatively correlated. One component of the investor sentiment index, IPO first-day return was found containing the rational factors and positively correlated with market system risk in the results reported by Guo (2011). He proves that IPO first-day return do have the positive explanatory ability for Cross-section Stock Returns by using Fama and French (1996) three factors model as a pricing model. Therefore, this paper further use Carhart (1997) four factors model to re-examine the explanatory ability of IPO first-day return on cross-sectional stock returns.On the other hand, however, except for measuring the stock return of irrational factors, investor sentiment index can also measure the risk factors, which may lead to the defect of capturing the stock return of irrational factors. In order to figure out this problem, this paper use Brown and Cliff (2004) orthogonal approach to detach the part of investor sentiment which can be explained by risk factors. Moreover, based on three(four) factors model, this study add orthogonal investor sentiment to our model. According to the empirical evidence, we find that the relationship between orthogonal investor sentiment and future cross-sectional stock return is significantly positive.