Analysis of “Investor Sentiment, Beta, and the Cost of Equity Capital”
In the study by Antoniou, Doukas and Subrahmanyam (2015), the researchers look at CAPM, beta, noise traders, periods of optimism and periods of pessimism to test a number of hypotheses: first, that optimistic times lure noise traders into buying high beta stocks, which causes high beta stocks to be overpriced;
Noise traders are defined as “young, single males, who lose the most from investing, and are the most susceptible to overconfidence” (Antoniou et al., 2015, p. 352). This definition is not explicitly given but is rather stated in terms of most unsophisticated traders being characterized by these qualities. Considering that about 90% of the market consists of insititutional investors—not retail buyers and certainly not noise investors—the ability of a small percentage of unsophisticated investors to drive price action in high beta stocks for a sustained period of time should be viewed as dubious at best. Volume alone should be an indication of how much interest is occurring in high beta stocks—and if high beta stocks are being pushed upwards in price during optimistic periods on low volume, there is likely to be an opposite reaction among sophisticated short sellers, which will inevitably drive the price down if support levels are not bolstered by buyers other than noise traders. If high beta stocks maintain high prices for a sustainable period (even if that period is optimistic—a problematic term in and of itself since the entire market has been “optimistic” since the first round of QE and only now with quantitative tightening seeming like a sure thing does a hint of pessimism begin to be surfacing) there is very likely to be a good portion of institutional investors also buying. So the hypothesis that noise investors are responsible for inflating high beta stocks over a sustained period of optimism is likely inaccurate at best.
The second hypothesis is that during pessimistic periods, noise traders flee high beta stocks because sell side analysts are less euphoric (“optimistic”) in their analysis, which causes high beta stocks to be positively priced. The problem with this hypothesis, as with the first one, is that perceptions of overpricing and underpricing are completely subject and depend entirely on one’s perspective, which is only proven correct...
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