Research; Wilbur O. and Ann Powers College of Business

Clemson study shows pros are driving sentiment-based stock mispricing


Supply and demand is well-recognized as the driving force behind the ups and downs of stock market prices. Further, prices seems to be sensitive to the overall mood of the market.

What isn’t as well established is the investor profile most responsible for artificially inflating or deflating the values of stocks.

Luke DeVault's research examines ties between investor sentiment and stock mispricing
Luke DeVault

Research conducted by a Clemson University assistant professor in the Department of Finance points to a different group of investors than what conventional research has for a long time identified as the culprit in driving sentiment-induced mispricing of stocks.

Luke DeVault has co-authored a research paper, “Sentiment Metrics and Investor Demand,” that identifies professionals, not individual investors, as those responsible for driving prices of risky stocks too high during optimistic periods and too low when market pessimism prevails.

“Current work demonstrates that investor sentiment can have a significant impact on the price of stocks. For instance, when market optimism is high, the demand for a risky stock may be greater and its price above their true value,” he said. “Conversely, during less optimistic times investors may demand safer securities, deflating the prices of risky and inflating the price of safe stocks.”

DeVault said conventional thinking on who was primarily driving sentiment-based mispricing of stocks rests on the belief that because institutions are the most sophisticated they should be less subject to market whims. It identified the individual, non-professional investor as the party most likely responsible for creating market shocks through their overly optimistic or pessimistic investing behaviors.

Conversely, DeVault and two other researchers have come to a very different conclusion.

“We found sentiment-based mispricing was being driven primarily by the sophisticated institutional investors,” DeVault said. “When sentiment influences a stock price up or down, it’s the institutional professionals who are most likely behind it.”

DeVault and his co-researchers examined institutional trades from 1980 to 2012 by reviewing 13(F) reports, which are filings required by the Securities and Exchange Commission. The reports are filed quarterly by all institutional investment managers who manage at least $100 million worth of assets and contain all of their equity holdings.

So, why is it the professionals, not individual investors, causing these sentiment-based fluctuations in stock pricing? DeVault said it has to do with who accounts for most of the buying and selling.

“The short answer is that institutional investors, such as hedge funds and mutual funds, make up the overwhelming bulk of trading. If anyone is driving pricing, they are a likely source. The less sophisticated, individual investors account for a much smaller fraction of the trading volume and have less price impact,” he said.

DeVault said the study of investor behavior is important because it provides an understanding on how prices are set. He added, the implications of this research are significant.

“If institutional investors continue to manage a larger and larger percentage of assets, it doesn’t mean the market is going to become more efficient. On the contrary, it could result in just the opposite, meaning the frequency of mispricing could increase.”

Joining DeVault in the research were Richard Sias, University of Arizona and Laura Starks, University of Texas. The research is available on the Journal of Finance website prior to it being published in the journal, the most widely cited academic journal on finance.

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