Investor Sentiment, Stock Returns, and Firm Characteristics: Evidence from a Leading Emerging Market

This study examines how investor sentiment affects asset returns in the Korean stock market, a representative leading emerging market, in different ways depending on firm characteristics. By analyzing the unique stock trading dataset containing rich information on investor types and sentiment, we construct the firm-level investor sentiment index and investor-type trading behavior index. We confirm that high investor sentiment induces higher stock market returns. The positive association between investor sentiment and stock returns is highly significant after controlling trading behavior and other risk and firm characteristics. Investor sentiment is shown to have stronger effects for small-firm, low-priced, high book-to-market ratio, high excess return, and highly volatile stocks, and stocks heavily traded by individual investors. The diverse degree and intensity of the sentiment effect across firm and stock characteristics are attributable to individual investors’ trading.