Market Response to Investor Sentiment

Recent empirical research suggests that measures of investor sentimenthave predictive power for future stock returns over the intermediate and longterm. Given the widespread publication of sentiment indicators, smart investorsshould trade on the information conveyed by such indicators and thustrigger an immediate market response to their publication. The present paperis the first to empirically analyze whether an immediate response can beidentified from the data. We use survey-based sentiment indicators from twocountries (Germany and the US). Consistent with previous research we findthere is predictability at intermediate time horizons. For the US, however,the predictability disappears after 1994. Using event study methodologywe find that the publication of sentiment indicators affects market returns.The sign of the immediate response is the same as that of the predictabilityover the intermediate term. This finding is consistent with the idea thatsentiment is related to mispricing, but is inconsistent with the idea that thesentiment indicator provides information about future expected returns.