Dual effects of investor sentiment and uncertainty in financial markets

Abstract

This study investigates the interplay between firm-level investor sentiment and uncertainty in financial markets. We demonstrate that investor sentiment significantly influences short-term stock market returns, particularly when there is an increase in firm-level uncertainty. This correlation becomes weaker among firms experiencing a decrease in uncertainty. The cross-sectional effect of sentiment is more pronounced during periods of heightened uncertainty, as evidenced by the higher returns of sentiment-based long-short portfolios under these conditions. Our findings are robust to adjusting for various factors and using alternative uncertainty and sentiment measures.