Constantinos Antoniou

Cognitive Dissonance, Sentiment, and Momentum

We consider whether sentiment affects the profitability of momentum strategies. We hypothesize that news that contradicts investors’ sentiment causes cognitive dissonance, slowing the diffusion of such news. Thus, losers (winners) become underpriced under optimism (pessimism). Short-selling constraints may impede arbitraging of losers and thus strengthen momentum during optimistic periods. Supporting this notion, we empirically show that momentum profits arise only under optimism. An analysis of net order flows from small and large trades indicates that small investors are slow to sell losers during optimistic periods. Momentum-based hedge portfolios formed during optimistic periods experience long-run reversals.

Investor Sentiment, Beta, and the Cost of Equity Capital

The security market line accords with the capital asset pricing model by taking on an upward slope in pessimistic sentiment periods, but is downward sloping during optimistic periods. We hypothesize that this finding obtains because periods of optimism attract equity investment by unsophisticated, overconfident, traders in risky opportunities (high beta stocks), whereas such traders stay along the sidelines during pessimistic periods. Thus, high beta stocks become overpriced in optimistic periods, but during pessimistic periods, noise trading is reduced, so that traditional beta pricing prevails. Unconditional on sentiment, these effects offset each other. Although rational explanations cannot completely be ruled out, analyses using earnings expectations, fund flows, the probability of informed trading, and order imbalances do provide evidence that noise traders are more bullish about high beta stocks when sentiment is optimistic, whereas investor behavior appears to accord more closely with rationality during pessimistic periods, supporting our hypothesis.We consider whether sentiment affects the validity of CAPM. We hypothesize that pessimistic periods have low levels of noise trading because co stly short-selling mutes trading on negative sentiment. On the other hand optimistic sentiment stimulates long positions that are easier to establish, and optimistic periods may also attract more naive investors, stimulating greater noise trading. Thus, optimistic periods may suppress rat ional pricing while pessimistic ones may accentuate the phenomenon. Empirically, using a st andard Fama and French (1992) approach, and controlling for other well-known cross-sectiona l return determinants, we find that beta is strongly and positively significant in pessimistic periods (but not in optimistic ones), with a tstatistic exceeding three, and a reasonable estimat e of the market risk premium. The evidence survives several robustness checks and supports the notion that rational asset pricing holds when the populace of agents trading in the market is mor e likely to be predominantly rational.

Sentiment and Momentum

This paper sheds empirical light on whether sentiment affects the profitability of price momentum strategies. We hypothesize that news that contradicts investors’ sentiment causes cognitive dissonance, which slows the diffusion of signals that oppose the direction of sentiment. This phenomenon tends to cause underpricing of losers under optimism and underpricing of winners under pessimism. While the latter phenomenon can be corrected by arbitrage buying, short-selling constraints impede arbitraging of losers under optimism, causing momentum to be stronger in optimistic periods. Our empirical analysis supports this argument by showing that momentum profits arise only under optimism, and are driven principally by strong momentum in losing stocks. This result survives a host of robustness checks including controls for market returns, firm size and analyst following. An analysis of net order flows from small and large trades indicates that small (but not large) investors are slow to sell losers during optimistic periods. Momentum-based hedge portfolios formed during optimistic periods experience long-run reversals.

Information Characteristics and Errors in Expectations: Experimental Evidence

We design an experiment to test the hypothesis that, in violation of Bayes Rule, some people respond more forcefully to the strength of information than to its weight. We provide incentives to motivate effort, use naturally occurring information, and control for risk attitude. We find that the strength-weight bias affects expectations, but that its magnitude is significantly lower than originally reported. Controls for non-linear utility further reduce the bias. Our results suggest that incentive compatibility and controls for risk attitude considerably affect inferences on errors in expectations.

Terrorist Attacks, Managerial Sentiment, and Corporate Policies

This paper examines whether extreme negative events such as terrorist attacks and mass shootings affect the sentiment of managers and consequently affect corporate policies. Specifically, we conjecture that terrorist events invoke negative sentiment among local corporate managers, which would induce them to adopt more conservative corporate policies. Consistent with our conjecture, we find that firms located near extreme negative events increase cash holdings, and reduce R&D expenditure as well as long-term leverage. These effects are temporary and they become weaker as the firm-event distance increases. Further, firms managed by younger CEOs exhibit a greater sensitivity to the events. We also find that salient events with greater media coverage induce larger shifts in corporate policies.This paper examines whether emotion-related biases induced by extraneous negative events affect corporate decision-making. Specifically, we conjecture that corporate managers located near major terrorist attacks will experience negative emotions, which would induce them to adopt more conservative corporate policies. Consistent with our conjecture, we demonstrate that firms located near terrorist events increase their cash holdings, and reduce their R&D expenditure and their long-term leverage around the events. These effects are temporary, become weaker as the distance between the firm and the event location increases, and are mainly concentrated among firms managed by younger CEOs. Using multiple media proxies to capture the saliency of negative events, we also find that events with greater media exposure are associated with larger changes in corporate policies. JEL Classification: G32, G02.

Ambiguity Aversion and Stock Market Participation: Evidence from Fund Flows

Stock market participation is very low, with approximately two thirds of all U.S. households not owning any public equity. This is a puzzle in the context of the basic Expected Utility model. One explanation put forward in the literature is that stock market participation is low because, in addition to risk, stocks also entail ambiguity and investors are ambiguity averse. We empirically test this hypothesis, measuring stock market participation using equity fund flows and ambiguity with dispersion in analyst forecasts about aggregate market returns. In a multivariate framework our results show that increases in ambiguity are significantly and negatively related to equity fund flows, and thus support the notion that limited market participation is related to ambiguity aversion.Stock market participation is very low, with approximately two thirds of all U.S. households not owning any public equity. This is a puzzle in the context of the basic Expected Utility model. One explanation put forward in the literature is that stock market participation is low because, in addition to risk, stocks also entail ambiguity and investors are ambiguity averse. We empirically test this hypothesis, measuring stock market participation using equity fund flows and ambiguity with dispersion in analyst forecasts about aggregate market returns. In a multivariate framework our results show that increases in ambiguity are significantly and negatively related to equity fund flows, and thus support the notion that limited market participation is related to ambiguity aversion.

Terrorist Attacks, Analyst Sentiment, and Earnings Forecasts

We examine whether exogenous and extremely negative events such as terrorist attacks and mass shootings influence the sentiment and forecasts of sell-side equity analysts. We find that analysts who are local to these attacks issue forecasts that are relatively more pessimistic than the consensus forecast. This effect is stronger when the analyst is closer to the event and located in a low-crime region. Impacted analysts are also relatively more pessimistic around the one- and two-year anniversaries of the attacks. Collectively, these findings indicate that exposure to extreme negative events affects the behavior of information intermediaries and the information dissemination process in financial markets.

Style Investing and Commonality in Liquidity

We examine whether commonality in liquidity arises from style investing. We sort stocks into styles along widely-used size and growth dimensions, and show that style-related commonality in liquidity is significant, dominates commonality in liquidity with the rest of the market, and has more than doubled in the last decade, when style investing has become prominent. Further, in cross sectional tests, we find that style-related commonality in liquidity is stronger for stocks with larger exposure to style investing. Finally, results from a natural experiment suggest that uninformed style investing induces significant liquidity covariation in excess of the covariation induced by fundamentals.

Bayesian Reasoning: Evidence from the Field

Beliefs should be affected more strongly by reliable signals. We test this notion, using beliefs inferred from bookmakers’ odds for tennis matches, exploiting exogenous variation in information reliability related to whether a tennis match is played in a long or short format. We find that bookmakers’ beliefs do not fully reflect the reliability of available signals. This insensitivity to information reliability is costly to bookmakers. Results from a placebo test using women’s matches, where all matches are played in the same format, support our conclusions. Insensitivity to information reliability affects beliefs in other sports-betting markets, as well as financial markets.