Journal of Empirical Finance 19 (2012) 217 –240
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Journal of Empirical Finance
journal h omepage: /locate/je mp fin
When does investor sentiment predict stock returns?
San-Lin Chung a,1, Chi-Hsiou Hung b,2, Chung-Ying Yeh c,?
a Department of Finance, National Taiwan University, 1, Section 4, Roosevelt Road, Taipei 106, Taiwan
b Durham Business School, Durham University, Mill Hill Lane, Durham, DH1 3LB, UK
c Department of Finance, National Chung Hsing University, 250, Kuo-Kuang Road, Taichung 402, Taiwan
a r t i c l e i n f o a b s t r a c t
Article history: We examine the asymmetry in the predictive power of investor sentiment in the cross-section
Received 13 November 2010 of stock returns across economic expansion and recession states. We test the implication of be-
Received in revised form 28 December 2011 havioral theories and evidence that the return predictability of sentiment should be most pro-
Accepted 19 January 2012 nounced in an expansion state when investors' optimism increases. We segregate economic
Available online 27 January 2012
states according to the NBER business cycles and further implement a multivariate Markov-
switching model to capture the unobservable dynamics of the changes in the economic regime.
JEL classification: The evidence suggests that only in the expansion state does sentiment perform both in-sample