Investor sentiment and the mean–variance relation

This study shows the influence of investor sentiment on the marketʹs mean–variance tradeoff. We find that the stock marketʹs expected excess return is positively related to the marketʹs conditional variance in low-sentiment periods but unrelated to variance in high-sentiment periods. These findings are consistent with sentiment traders who, during the high-sentiment periods, undermine an otherwise positive mean–variance tradeoff. We also find that the negative correlation between returns and contemporaneous volatility innovations is much stronger in the low-sentiment periods. The latter result is consistent with the stronger positive ex ante relation during such periods.