Investor Sentiment And Cross Sectional Stock Returns: Empirical From Chinese A Share Market

This paper aims to examine the investor sentiment effect on Chinese A sharemarket from both market-level and cross-sectional level, contributing to providingmore insights on Chinese market, where only a few empirical work has been doneon this field.Firstly, the paper constructs a market-level sentiment index from1998.08to2012.11, using Principal Component Method. Then I construct stock portfolios onthe basis of firm characteristics including size, age, past volatility, book-to-marketratio, institutional ownership and tradable A shares. Based on the sentiment index,this paper tests the predictability of sentiment on market-level return, and thefurthermore cross-sectional stock returns.Results show that investor sentiment has contrarian predictability inmarket-level return when lagged period equal to5months. Further, more influenceis found to be exerted on the market return by investor sentiment in high sentimentperiods than in low sentiment periods As for cross-sectional returns, non-parametricanalysis shows that young, high volatile and growth stocks are more easily affectedby sentiment; big firms and small firms react more to sentiment than middle-sizefirms. Regression analysis supports that highly volatile stocks, growth stocks andstocks with less institutional investors are more easily affected by sentiment for thefull sample period. When dividing the sample period into before and after June2005,it is shown that in period after June2005, the predictability power of sentiment isstronger than before June2005for most of the firm characteristics.