Investor Sentiment, Anomalies, and Macroeconomic Conditions

We examine whether the results supporting the sentiment-related overpricing story by Stambaugh, Yu, and Yuan (J. Financial Economics, v. 104, p. 288-302) are still valid after controlling for macroeconomic conditions. We no longer find the results consistent with the sentiment-related overpricing story after adjusting for the effect of macroeconomic conditions. The risk factors associated with macroeconomic conditions are mostly priced, and the average return spread in the anomalies is largely accounted for by the expected return spread implied by the risk factors. Their results might be a consequence of the use of an inadequately constructed sentiment index. It is premature to argue that the returns in the anomalies are driven by investor sentiment.