Nonlinear effect of sentiment on momentum

Research output: Contribution to journalArticlepeer-review

Abstract

I study a Lucas exchange economy with many trees and a representative agent who forms extrapolative beliefs on market returns (market-wide sentiment). As a result of sentiment spillovers, the agent believes that there is momentum in the cross section of asset returns. However, from the point of view of an outside econometrician, the market price of risk relates negatively to sentiment. This, together with the subjective momentum, causes returns on momentum strategies to be a concave function of sentiment, leading to a downside risk of momentum. I find empirical evidence consistent with model predictions.
Original languageEnglish
Article number104253
Pages (from-to)1-22
Number of pages22
JournalJournal of Economic Dynamics and Control
Volume133
DOIs
Publication statusPublished - Dec 2021

Keywords

  • Extrapolation
  • Investor sentiment
  • Spillovers
  • Momentum
  • Skewness

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