Investor Sentiment and Asset Valuation

TLDR: In this article, the link between asset valuation and investor sentiment is investigated and it is shown that market pricing errors implied by an independent valuation model are positively related to sentiment, while future returns over multi-year horizons are negatively related with sentiment, and the results are robust to the inclusion of other variables that have been shown to forecast stock returns.

Abstract: The link between asset valuation and investor sentiment is the subject of considerable debate in the profession. If excessive optimism drives prices above intrinsic values, periods of high sentiment should be followed by low returns, as market prices revert to fundamental values. Using survey data on investor sentiment, we provide evidence that sentiment affects asset valuation. Market pricing errors implied by an independent valuation model are positively related to sentiment. Future returns over multiyear horizons are negatively related to sentiment. These results are robust to the inclusion of other variables that have been shown to forecast stock returns.