Investor Sentiment and the Risk‐Return Relation: A Two‐in‐One Approach

Traditional finance theory posits a positive risk–return relation, but empirical evidence is inconclusive. Retail investor sentiment has long been viewed as a distorting factor, while more recently institutional investor sentiment is thought to play a role. We examine the separate and joint impacts of retail and institutional investor sentiments on the risk-return relation. We find, at both market and firm levels, the risk-return relation is more likely to be distorted by the two investor-type sentiments jointly, rather than separately. We further find a cross-sectional pattern, with the risk-return relation being more sensitive to investor sentiment for stocks with specific characteristics

Do socially responsible investment funds sell losses and ride gains? The disposition effect in SRI funds

An increasing percentage of the total net assets under professional management is devoted to ethical investments. Socially responsible investment (SRI) funds have a dual objective: building an investment strategy based on environmental, social, and corporate governance (ESG) screens and providing financial returns to investors. In the current study, we investigate whether this dual objective has an influence on the behavior of mutual fund managers in the realization of gains and losses. Evidence has shown that most investors in SRI funds invest in those funds primarily because of their social concerns. If the motivations of SRI managers align with those of SRI investors, SRI managers might then have more incentives than conventional managers to hold onto losing stocks if they feel their social value compensates for the economic loss. We hypothesize that SRI managers would be less prone to the disposition effect than conventional managers. Pertaining to the disposition effect, we do not find evidence of a difference in the behavior of SRI fund managers compared with that of conventional fund managers. Our results hold, even when considering market trends, management structure, gender, and prior performance

Market Efficiency and the Role of Information: An Experimental Analysis

The purpose of this research is to gain additional insight concerning the highly efficient market outcomes generated under the rules of trade of the double auction, in which traders have the dual role of both buyer and seller and can simultaneously call out offers to buy and sell. It is conjectured that the experimental literature’s robust results detailing the efficiency of the double auction institution may be a product of the constant and known duration of trade incorporated in previous experimental designs. In one of the few relevant theoretical discussions Friedman (1984, p.71) suggests that the predetermined, known time at which trade will cease is one of a number of institutional features of experimental double auction markets that enhance the efficiency of observed market outcomes. Known trading duration may well be a key variable in the determination of the price formation process and the convergence to competitive equilibrium in the double auction institution. This study extends previous work by conducting a series of experiments designed to determine the importance of trading duration on the convergence tendencies of experimental asset markets governed by the rules of the double auction institution. The issue is of substantive theoretical and practical interest. The results of this study offer a number of conclusions. Aggregated across the eighteen experimental asset markets studied, transaction prices tend to exhibit convergence to competitive outcomes. Importantly, the etlect of known period duration on observed market behaviour is significant. Experimental asset markets that incorporate uncertain trading durations display more aggressive trading strategies. This is evidenced by an increase in the rate of trade relative to markets where the duration of trade varies but is known. The markets with uncertain trading durations also exhibit reduced levels of market efficiency relative to the other markets studied. The implication is clear, any future refinement of either theoretical models or institutions of exchange must explicitly recognise the effect of uncertain trading duration on market behaviour in double auctions

Institutional investor sentiment and the mean-variance relationship: Global evidence

Although a cornerstone of traditional finance theory, empirical evidence in support of a positive mean-variance relation is far from conclusive, with the behavior of retail investors commonly thought to be one of the root causes of departures from this expected relationship. The behavior of institutional investors, conventionally thought to be sophisticated and rational, has recently come under closer scrutiny, including in relation to investor sentiment. Drawing together these two strands of literature, this paper examines the impact of institutional investor sentiment on the mean-variance relation in six regions, including Asia (excl. Japan), Eastern Europe, Eurozone, Japan, Latin America, and the US, and across thirty-eight markets. Empirical evidence supports the differential impact of institutional investor sentiment on the mean-variance relation (i.e., positive or negative), both across regions and across markets. In particular, for markets with cultural proneness to overreaction and a low level of market integrity institutional investor sentiment tends to distort the risk-return tradeoff

The conditional impact of investor sentiment in global stock markets: A two-channel examination

While investor sentiment has been shown to have a robust, direct impact on stock returns, we know little about how it impacts returns through an indirect channel from conditional volatility. We conduct a global study of investor sentiment across 40 international stock markets to examine the impact of investor sentiment on stock returns via both direct and indirect channels and how the impact varies across bull and bear market regimes. Using turnover ratio as the sentiment proxy and applying GARCH-type models, we confirm a conditional impact of investor sentiment on stock returns via both channels: In bull regimes, optimistic (pessimistic) shifts in investor sentiment would increase (decrease) stock returns, while in bear regimes, optimistic (pessimistic) shifts would decrease (increase) stock returns

Investor sentiment and stock returns: Global evidence

We assess the impact of investor sentiment on future stock returns in 50 global stock markets. Using the consumer confidence index (CCI) as the sentiment proxy, we document a negative relationship between investor sentiment and future stock returns at the global level. While the separation between developed and emerging markets does not disrupt the negative pattern, investor sentiment has a more instant impact in emerging markets, but a more enduring impact in developed markets. Individual stock markets reveal heterogeneity in the sentiment-return relationship. This heterogeneity can be explained by cross-market differences in culture and institutions, along with intelligence and education, to varying degrees influenced by the extent of individual investor market participation

Capital Structure, Management Ownership and Large External Shareholders: A UK Analysis

This paper examines empirically the effects of management ownership and ownership by large external shareholders on the capital structure of the firm from an agency theory perspective. The paper extends the US literature on the topic by examining the effect of interactions between management ownership and ownership by large external shareholders on the capital structure of UK firms. For a sample of UK firms, the paper provides empirical evidence that suggests the debt ratio is positively related to management ownership and negatively related to ownership by large external shareholders. Furthermore, the presence of a large external shareholder acts to negate the positive relationship between debt ratios and management ownership; in the presence of a large external shareholder, no significant relationship between debt ratios and management ownership exists. These findings are consistent with the hypothesis that the presence of large external shareholders affects the agency costs of debt and equity.Capital Structure, Management Ownership, External Shareholders,

Mental accounting and decision making: Evidence under reverse conditions where money is spent for time saved

Evidence from the behavioural decision literature suggests that economic decisions may be made on less than rational grounds. In this respect the formation of ‘mental accounts’ by individuals has been used to explain apparent departures from rationality in certain scenarios. The purpose of this paper is to establish the general applicability of mental accounting by investigating multi-attribute decisions where the following conditions vary: (1) the denomination of the mental account (i.e. whether the saving is denominated in money, as is classically the case, or time) and (2) the absolute saving level. Using a novel decision scenario, we replicate the prior findings of mental accounting effects under the classical conditions where individuals trade-off time spent for money saved, though these effects are sensitive to the level of absolute saving. However, when the conditions of the decision scenario are reversed, such that individuals trade-off money spent for time saved, mental accounting effects are no longer observed. This result is robust irrespective of whether participants are required to state maximum willingness to spend time/money or face a choice (yes/no) task. These findings qualify the results reported in prior studies, suggesting that mental accounting effects maybe context specific and suffer from a lack of generality

A behavioural appraisal of regulatory financial reforms and implications for corporate management

Financial markets play a vital role in shaping corporate behaviour, impacting corporate financial decisions ranging from investment and mergers/acquisitions to payout policies and management renumeration. Financial markets, however, are prone to irrational sentiments to trade, driving prices away from fundamental values, with the potential to distort corporate decisions and, hence, corporate efficiency. It is important, therefore, to examine the extent to which regulatory reforms help mitigate the influence of irrationality in financial markets. To this end, we examine the consequences of the mandatory adoption of International Financial Reporting Standards (IFRS) in Europe through the behavioural lens of investor sentiment. In country-level analyses, we find the impact of irrational sentiment on stock markets to have significantly diminished post-IFRS. In global pooled analyses, we compare the change in the sentiment–return relationship in countries adopting IFRS with the change in a set of non-adopting countries to account for stock market trends: weakening of the impact of irrational sentiment on stock prices is greater in IFRS adopting countries. Results are robust to a battery of alternative tests and explanations. We provide strong support, therefore, for the success of IFRS in its aim of improving market efficiency, with important implications for corporate management