Sentiment and Stock Return Comovement

Research Interest
We find that the stock return comovement following high sentiment periods is lower than that following low sentiment periods. Motivated by Veldkamp (2006a, 2006b) and Morck, Yeung and Yu (2013) (MYY 2013), we examine two channels through which investor sentiment may affect stock return comovement: the firm-specific information production channel and the firm-specific fundamental volatility channel. We find that investor sentiment increases firm-specific information production. The negative relation between investor sentiment and stock return comovement is more pronounced in the stocks that have higher news coverage, higher analyst coverage, lower cost of short selling and higher institutional ownerships, which supports the firm-specific information channel. We also find that following high sentiment periods, the cost of equity capital is lower and the innovation output is higher. The negative relation between investor sentiment and stock return comovement is also more pronounced in the stocks whose values are sensitive to innovations, consistent with the hypothesis made by MYY (2013) that high sentiment will accelerate creative destructions that elevate firm-specific fundamental volatility.