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Investor sentiment, investor crowded-trade behavior, and limited arbitrage in the cross section of stock returns

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  • Liyun Zhou

    (South China Agricultural University)

  • Chunpeng Yang

    (South China University of Technology)

Abstract

We examine the interaction effects of investor sentiment, investor crowded-trade behavior, and limited arbitrage on the cross section of stock returns. This paper presents strong evidence to reveal that investor crowded-trade behavior will increase stock prices greatly (little) among stocks with positive (negative) investor sentiment; and investor sentiment will increase (not increase) stock prices among stocks with extreme seller-initiated (buyer-initiated) crowded-trade behavior. Furthermore, this paper finds that the benchmark-adjusted returns are positive among stocks with relatively positive investor sentiment and buyer-initiated crowded-trade behavior, and negative among stocks with relatively negative investor sentiment and seller-initiated crowded-trade behavior. Finally, this paper demonstrates that limited arbitrage plays more roles on stocks with pessimistic sentiment and seller-initiated crowded-trade behavior. Taken together, this paper confirms the combined effects of investor sentiment and investor crowded-trade behavior on the cross section of stock returns, and further explores the moderating effect of limited arbitrage.

Suggested Citation

  • Liyun Zhou & Chunpeng Yang, 2020. "Investor sentiment, investor crowded-trade behavior, and limited arbitrage in the cross section of stock returns," Empirical Economics, Springer, vol. 59(1), pages 437-460, July.
    • Handle: RePEc:spr:empeco:v:59:y:2020:i:1:d:10.1007_s00181-019-01630-7
    DOI: 10.1007/s00181-019-01630-7
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    5. Pedro Manuel Nogueira Reis & Carlos Pinho, 2021. "A Reappraisal of the Causal Relationship between Sentiment Proxies and Stock Returns," Journal of Behavioral Finance, Taylor & Francis Journals, vol. 22(4), pages 420-442, October.
    6. Chen, Haozhi & Zhang, Yue, 2023. "Research on the effect of firm-specific investor sentiment on the idiosyncratic volatility anomaly: Evidence from the Chinese market," Pacific-Basin Finance Journal, Elsevier, vol. 81(C).
    7. Kim, Karam & Ryu, Doojin & Yang, Heejin, 2021. "Information uncertainty, investor sentiment, and analyst reports," International Review of Financial Analysis, Elsevier, vol. 77(C).

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