FIN-03-030 |
NYU Stern School of Business |
November 2003
Malcolm Baker and Jeffrey Wurgler
ABSTRACT
We examine how investor sentiment affects the cross-section of stock returns. Theory predicts
that a broad wave of sentiment will disproportionately affect stocks whose valuations are highly
subjective and are difficult to arbitrage. We test this prediction by studying how the cross-section
of subsequent stock returns varies with proxies for beginning-of-period investor sentiment. When
sentiment is low, subsequent returns are relatively high on smaller stocks, high volatility stocks,
unprofitable stocks, non-dividend-paying stocks, extreme-growth stocks, and distressed stocks,
consistent with an initial underpricing of these stocks. When sentiment is high, on the other hand,
these patterns attenuate or fully reverse. The results are consistent with theoretical predictions
and are unlikely to reflect an alternative explanation based on compensation for systematic risks.
Malcolm Baker
Institution: Harvard Business School
Email: mbaker@hbs.edu
Jeffrey Wurgler
Institution: Stern School of Business, New York University, 44th West 4th Seet, New York, NY 10012
Telephone: (212) 998-0367
Fax: (212) 995-4233
Email: jwurgler@stern.nyu.edu
Homepage: http://www.stern.nyu.edu/~jwurgler/
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