Short-selling Constraint, Individual Stock Investment Sentiment And Stock Return

According to Miller’s analysis, short selling constraint and heterogeneous beliefsare the two factors that affect stock return. As a new economy, China’s financialmarket is still immature, especially the long-term lack of short selling mechanism,which make investors with heterogeneous beliefs silence. Both individual andinstitutional investors in domestic market have irrational behavior which brings severemarket unilateral emotion and results in herding effect. Under the condition ofrelaxing short selling constraint gradually in domestic market, the paper base onindividual stocks data, use principal component factor analysis and text analysis andseparately construct individual stock investor sentiment factor and media sentimentfactor to test whether investor sentiment deviation has significant negative effect onstock abnormal returns, whether the media sentiment has “spiral effect”, whether theshort term “momentum effect” and the “reverse effect” exist under different degree ofshort-selling constraint. The conclusions are as follow:Firstly, under short-selling constraint, the sentiment factor has positivecorrelation with stock return. The prior optimism has “momentum effect” on nextstock return while negative emotion has significant “reversal effect”. The abnormalreturn of stock portfolio with polarized emotion is commonly greater than the moremoderate stock portfolio. The media sentiment is an important factor to form the biasof individual stock investment sentiment; secondly, relaxing the short-sellingconstraint, the media sentiment has negative correlation with stock return. The“spiral effect” that media sentiment has on individual investors disappears. The stockabnormal return corrects to a certain degree. The average return of stock withmoderate investor sentiment is higher which is consistent with Miller’point. What ismore, in the monthly investment cycle, the short-selling constraint factor has“momentum effect” on the investor sentiment stock portfolio which bringssignificant negative correction. The influence that media sentiment has on stockportfolio is similar to investor sentiment, but the “momentum effect” weakening inthe quarter and half year investment cycle; thirdly, the abnormal returns of the mostactive short-selling and the most optimistic stock portfolio present large “reversaleffect” instead of revising obviously which is different from Miller’opinion. The lagbehind of Chinese stock market and high short-selling cost pushed by limited channels restrict the role that short-selling plays. Based on the influence thatsentiment factors put on the stock return deviation, there is a suggestion that buyingthe prior most active stock and sell out the most inactive stock especially theoptimistic one to get excess profits.As a whole, relaxing selling out cannot completely correct the individual stockabnormal return, even become the tool of short term speculative trading which hasdirect relationship with the scope and the way taken to relax the short-selling. It alsoillustrates that the traditional three factors model cannot fully explain the actual stockprice change and it is necessary to take in the investment sentiment factor.