Volume 23 Issue 1 (January-March 2007)

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Institutional and individual sentiment: Smart money and noise trader risk?

Schmeling, M.
Pages 127-145

Using a new data set on investor sentiment, we show that institutional and individual sentiment seem to proxy for smart money and noise trader risk, respectively. First, using bias-adjusted long-horizon regressions, we show that institutional sentiment forecasts stock market returns at intermediate horizons correctly, whereas individuals consistently get the direction wrong. Second, even the simplest possible trading strategies based on investor sentiment show clear tendencies toward being profitable after controlling for systematic risk. Finally, IV regressions show that institutional investors take into account expected individual sentiment when forming their expectations, in a way that is consistent with the view that individual investors can be a proxy for noise trader risk. However, there is evidence of structural change.

Keywords: [jel] G11 , [jel] G12 , [jel] G14 , Individual investor sentiment , Institutional investor sentiment , Predictive regressions , Noise trader , Smart money
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