ARTICLE | JOURNAL OF FINANCIAL ECONOMICS | MAY 2012

Global, Local, and Contagious Investor Sentiment

by Malcolm Baker, Jeffrey Wurgler and Yu Yuan

Abstract

We construct investor sentiment indices for six major stock markets and decompose them into one global and six local indices. In a validation test, we find that relative sentiment is correlated with the relative prices of dual-listed companies. Global sentiment is a contrarian predictor of country-level returns. Both global and local sentiment are contrarian predictors of the time-series of cross-sectional returns within markets: When sentiment is high, future returns are low on relatively difficult to arbitrage and difficult to value stocks. Private capital flows appear to be one mechanism by which sentiment spreads across markets and forms global sentiment.

Keywords: Business and Shareholder Relations; Globalization; Stocks; Markets; Capital; Financial Services Industry