Effect of Investor Sentiment on Cross Sectional Stock Returns Case Study

Effect of Investor Sentiment on Cross Sectional Stock Returns - Case Study Example Competition among them leads to a balance in which prices equal the reasonably inexpensive value of expected cash flows, and in which the cross-section of predictable returns depends only on the cross-section of systematic risks. Even if some investors are irrational, classical theory argues, their strain are offset by arbitrageurs with no momentous impact on prices. In this paper, we present evidence that investor sentiment may have major effects on the cross-section of stock prices. Investment sentiments with in the stock market and the effect of investor emotions on stock returns are certainly the first issue that investors should consider. At the outset, investing is an act of faith, a willingness to postpone present consumption and save for the future. Investing for the long term is central to the achievement of optimal returns by investors. Unfortunately, the principle of investing for the long term-eschewing funds with high turnover portfolios and holding shares in soundly managed funds as investments for a lifetime- is honoured more in the breach than in the observance by most mutual fund managers and shareholders. (Arbel, 1983 44) The term second-hand information refers to information that has been collected from public sources and manipulated or simply reported again by a public news source. Prior research documents the existence of abnormal returns upon the announcement of secondhand information in the form of analysts' recommendations published in a variety of business periodicals. These abnormal returns generally are found to be short-lived. Explanations of the abnormal returns associated with second-hand information include the fact that the market may be inefficient; that second-hand information increases attention focused on the company; that it increases the volume of trading, putting price pressure on the company's stock; and that it provides new information about the company's future prospects or reduces uncertainty associated with previous reports about the company. The objective of this study is to provide additional evidence on the impact of secondhand information on stock prices. We examine a source of information heretofore untested in the finance literature: stock purchase recommendations contained in the widely read weekly business periodical Barron's. The different sources of information in Barron's allow us to examine additional explanations of the impact of second-hand information. We also explore the impact of firm size on the stock price reaction to the disclosure of second-hand information. Literature Review The results provide additional evidence that second-hand information has an impact on stock prices. Consistent with prior studies of other sources of second-hand information, the results show that Barron's recommendations have a substantial impact on stock