Investor sentiment and the predictability of asset returns: Evidence from China

In contrast to previous studies, we redefine the category of "rationality" from the perspective of investors’ pursuit for wealth maximization. Using the data from Chinese stock market, this paper studies the impact of rational and irrational sentiment on asset returns from short-term to long-run. We find that irrational sentiment has stable positive predictability on the future returns in short term while it is a reverse indicator in the long run. Meanwhile, the rational sentiment accurately forecasts both the future short-term and long-run returns. Our findings indicate that the predictability of investor sentiment on returns is closely related to time interval chosen in research and the level of feedback between investor sentiment and asset prices.