The purpose of this paper is to use investor sentiment (IS) as a conditioning information variable for the cross-sectional return predictability tests of alternative asset pricing models (APMs).
Cross-sectional tests of alternative APMs in the linear beta representation and stochastic discount factor specifications, Fama and Macbeth and generalized method of moments techniques have been used.
Results reveal that IS as a conditioning information variable contains significant information for making the discount factors time varying. Model comparison test statistics suggests that among the alternative APMs, the conditional five-factor model (FFM) performs better.
Empirical analysis does not extend to the inclusion of the business-cycle conditioning information variables for the test of APMs.
The potential benefit of the conditional FFM can be leveraged upon for cost of capital determination, and mutual fund manager’s portfolio performance evaluation when the portfolio is heavily weighted with sentiment-sensitive hard to value and difficult to arbitrage stocks. During volatile and boom periods in stock markets the IS scaled conditional APMs may be useful for the fundamental value determination of sentiment-sensitive stocks.
This study extends available literature in the context of both developed and emerging equity markets by exploring the cross-sectional tests of conditional APMs using IS as the conditioning information variable. To the author’s knowledge, this is perhaps the first study that examines IS as conditioning information for the cross-sectional tests of alternative APMs.
Author wishes to thank the conference participants at the India Finance Conference-2013 and the Australian Academy of Business and Social Sciences Conference 2014 for their valuable comments. A special and sincere gratitude to Dr Jitendra Mahakud (Department of Humanities and Social Sciences, Indian Institute of Technology Kharagpur, India) for his constructive advice, review comments on preliminary drafts for the conference presentation and encouragement throughout the doctoral research work. The author would like to thank the anonymous referee, Professor Javed Iqbal, and Professor Robert Brooks for helpful comments. All remaining errors are mine.
Dash, S. (2016), "Does investor sentiment as conditioning information help to explain stock returns behaviour? A test of alternative asset pricing models", Review of Behavioral Finance, Vol. 8 No. 2, pp. 174-198. https://doi.org/10.1108/RBF-03-2014-0022Download as .RIS
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