A Stock-Level Measure Of Investor Sentiment

I quantify the impact of stock-level investor sentiment assuming that emotional investors are more likely to suffer from myopia, make shortsighted decisions and hence, trade excessively in bullish markets and ride losses at bearish times. By using wavelets transforms to isolate the effects of rash trade, I construct an Investor Sentiment Revealed by the Activities of Shortsighted Holders (ISRASH) index as a new measure of sentiment. Using a sample of US common stocks traded on NYSE, AMEX, and Nasdaq in the period from 1984 to 2013, I find ISRASH predicts momentum in cumulative returns over the next 8 days; and predicts return reversals in two years. I also find that the effects of the beginning-of-period ISRASH are relatively high on returns on small stocks, high beta stocks, and volatile stocks. Additional tests suggest that these findings are unlikely to be driven by compensation for well-known risk factors.