Understanding the role of sentiment beta in China

Abstract

In this work, we focus on the relationship between stocks’ sensitivity to investor sentiment and cross-sectional returns in China. We construct sentiment beta, along with its absolute, positive, and negative variations. Our findings reveal that raw sentiment beta is not priced in cross-sectional returns, whereas the absolute version is. Further analysis demonstrates that the positive sentiment beta better predicts stock returns, in contrast to the insignificant impact of negative sentiment beta. The performance of positive sentiment beta remains significant after controlling for related firm attributes from any specific category; however, it can be jointly explained by all other attributes except for the limit of arbitrage. In light of Baker and Wurgler (2006), we conclude that varying sentimental shocks drive the performance of positive sentiment beta in China.