Impact of Investor Sentiment on Stock Return: Evidence from India

This paper tries to analyse the role of investor sentiment on stock returns in the Indian stock market. Following the top-down approach and by using various market related implicit sentiment proxies this paper attempts to construct an investor sentiment index for the sample period spanning from February 2003 till March 2011. The impact of sentiment risk on the cross sectional return variation of several double shorted value weighted portfolios have been investigated using multivariate time series estimation approach. Empirical findings suggest that, cross-sectional return variation is attributable to the sentiment effect and investor sentiment is a priced source of risk. Consistent with the prior literature the effect holds even after controlling for systematic risk factors like market excess return, size, book-to-market equity, momentum and liquidity. The negative pricing effect of sentiment risk on stock return is attributable to the fact that, since positive sentiment results in over valuation of stocks, the expected return for such stocks will be lower in the subsequent period.