Mispricing in the Stock Market - an effect of investor sentiment?

Abstract

The purpose of this thesis is to investigate the relationship between mispricing and investor sentiment, on the Swedish and European stock markets. Firstly, it examines whether mispricing is more prominent in periods following high sentiment. Similar studies have been conducted for other markets, such as the US, but, at least to the knowledge of the authors, no corresponding study has been performed on the markets of this thesis, particularly the Swedish. The results of the analysis display that, for the value strategy, there is a positive relation between the level of sentiment, and the subsequent excess returns measured, suggesting that mispricing is more prominent in periods following high sentiment. This relationship does also hold true for the size strategy in the Swedish market, but not in the European. Secondly, the thesis examines whether knowledge about the level of investor sentiment can be used to improve the returns of value- and size strategies. The results from this analysis display that returns of a value strategy can be improved with the use of investor sentiment. This also holds true for the size strategy in the Swedish market, but the average returns are primarily negative. Robustness tests are also conducted, to verify that the results found in this thesis are reliable. The main contribution from this thesis is found in the results corresponding to the value strategy, whilst the size strategy in the European market poses somewhat of a limit.