Investor sentiment and the risk–return relation: A two‐in‐one approach

Abstract

Traditional finance theory posits a positive risk–return relation, but empirical evidence is inconclusive. Retail investor sentiment has long been viewed as a distorting factor, while more recently institutional investor sentiment is thought to play a role. We examine the separate and joint impacts of retail and institutional investor sentiments on the risk‐return relation. We find, at both market and firm levels, the risk‐return relation is more likely to be distorted by the two investor‐type sentiments jointly, rather than separately. We further find a cross‐sectional pattern, with the risk‐return relation being more sensitive to investor sentiment for stocks with specific characteristics.