Investor Sentiment and Industry Cost of Equity: The Role of Information and Product Market Uniqueness

This paper documents a strong negative relationship between investor sentiment, proxied by the Michigan Consumer Sentiment Index, and cost of equity capital, suggesting that the market prices the predominant market-wide sentiment along with other risk factors. Furthermore, we investigate whether certain features of product market affect expected returns through investor perceptions. While we find no significant marginal effect of sentiment in competitive industries (where sales are spread across many firms), we show that the effect of market overreaction is more pronounced for unique industries (measured by the industry’s median ratio of selling ex-pense to sales). Finally, we observe an inverse relationship between sentiment and industry av-erage degree of market synchronicity (measured by the magnitude of explained variation in stock returns based on the market model). Specifically, we find that the implied cost of equity for in-dustries with lower average market synchronicity is more (negatively) sensitive to investor sen-timent. Our findings are in line with those observed in the behavioural finance literature, which show a more pronounced effect of sentiment on highly volatile stocks