Sentiment Dispersion and Asset Pricing Error: Evidence from the Chinese Stock Market

ABSTRACT

Previous studies have suggested that the impact of investor sentiment on asset pricing error is determined by the difference between the aggregate sentiment of optimistic and pessimistic investors. This article has found the influence of the in-group sentiment dispersion of optimistic and pessimistic investors on pricing error. We established a two-period model of heterogeneous investors and described the sentiment dispersion of the optimistic and pessimistic groups with the variance of sentiment bias. The results suggested that when the sentiment dispersion of the two groups are identical, the pricing error depends on the aggregate sentiments of the optimistic and pessimistic groups. Conversely, when the two groups have different sentiment dispersion, the pricing error is determined by both the sentiment dispersion ratio and the aggregate sentiment ratio. Finally, data from the Chinese stock market are generated to verify the above conclusions.

KEY WORDS:

• Heterogeneous investors
• pricing error
• sentiment dispersion

Notes

1. Earlier studies adopted certain market indicators to measure the aggregate sentiment of the market. For instance, Baker and Wurgler (2006) measured the overall market sentiment by using the market data, such as the number of IPOs, the dividend premium, the turnovers, the first-day return of IPO, and other indicators. With the advent of social media, many studies have extracted optimistic and pessimistic sentiments from social media, believing that the difference between the two kinds of sentiments represents the overall sentiment of the market.

2. An investor also can be rational and has neutral sentiment. However, the neutral investor is not introduced into the model, because the neutral investors have a sentiment of 0. The influence of neutral investors is eliminated and has no effect on the expectation of pricing error. For simplicity, we omit to model the behavior of neutral investors.

3. Since the purpose of this empirical study is to be able to measure the sentiment dispersion, we choose data on stock message boards to measure the sentiment of each investor. Other methods, such as analyst reports, IPO quantity, and investor confidence, are also proxies for investor sentiment. However, they are aggregate sentiment proxies for the whole investor group. If we want to measure the sentiment dispersion of each investor, these variables are not appropriate. Thus, we ultimately choose the stock message board data rather than other sentiment measurements.

Additional information

Funding

This paper was supported by the National Natural Science Foundation of China (Grant No. 71532009, 71790594 and 71871157), the Ministry of Education in China (MOE) Project Humanities and Social Sciences (Young Scholar Grant No. 14YJC790029).