Individual stock crowded trades, individual stock investor sentiment and excess returns

Outline

• Abstract
• Jel Classification
• Keywords
• 1. Introduction
• 2. Literature Review
• 3. Preliminary Analyses
• 3.1. the Individual Stock Investor Sentiment Index
• 3.2. the Individual Stock Crowded-Trade Indexes
• 3.3. Summary Statistics
• 4. Individual Stock Crowded-Trade Effect and Individual Stock Investor Sentiment Effect
• 4.1. Regression Results Excluding the Fama-French Three Factors of China Stock Markets
• 4.2. Regression Results Including the Fama-French Three Factors of China Stock Markets
• 5. Individual Stock Buyer-Initiated Crowded-Trade Effect, Individual Stock Seller-Initiated Crowded-Trade Effect, and Individual Stock Investor Sentiment Effect
• 5.1. Regression Results Excluding the Fama-French Three Factors of China Stock Markets
• 5.2. Regression Results Including the Fama-French Three Factors of China Stock Markets
• 6. Robustness Tests
• 7. Conclusion
• Acknowledgements
• References

Conclusions

Understanding the combined effect of investor behavior and investor sentiment on the formation of stock prices is an important issue in behavioral finance. In this paper, we offer explanations of excess returns with individual stock crowded trades and individual stock investor sentiment.

We show directly that individual stock crowded trades and individual stock investor sentiment have significant effects on excess returns. Specifically, we find that excess returns increase with individual stock crowded trades and individual stock investor sentiment including or excluding the Fama-French three factors of China Stock Markets. Furthermore, excess returns increase with individual stock buyer-initiated crowded trades, and decrease with individual stock seller-initiated crowded trades including or excluding the Fama-French three factors of China Stock Markets. These evidences are consistent with the view that both investor behavior and investor sentiment have significant impacts on excess returns.

Overall, our results have two important takeaways. First, compared with the roles of market-wide sentiment (see, e.g., Baker & Wurgler, 2006, 2007; Stambaugh, Yu, & Yuan, 2012) or institutional-level crowded trades (see, e.g., Pojarliev & Richard, 2011; Sias et al., 2016), we shed new light on the combined effects of stock-level sentiment and stock-level crowded trades on asset prices. Second, the joint effects of individual stock crowded trades and individual stock investor sentiment are significant and robust, which demonstrates the important roles of ‘‘anomaly factors” in asset pricing.

Our findings also raise a number of interesting issues for further research. First, we can test how the cross-section of stock returns varies with crowded trades and investor sentiment. Moreover, taking the role of investor sentiment into account, it would be interesting to examine how overcrowding trades affect stock prices, and further reveal whether stock prices far away from fundamentals with overcrowding trades and extreme investor sentiment. We hope to address these topics in our ongoing research.