Investors' Judgments, Asset Pricing Factors and Sentiment

This paper presents results based on new data showing that the relationships involving investors' judgments of risk and variables such as beta, size, and book‐to‐market equity (B/M) have the same directional effects as those involving realised returns. Moreover, the relationships involving risk are mediated by Baker–Wurgler sentiment, with directional effects similar to those that have already been documented for realised returns. In this regard, Baker‐Wurgler sentiment mediates the time series of investors' judgments of expected return and the cross‐section of their judgments about risk. The results are consistent with the position that investors' judgments of risk and return, both mediated by sentiment, influence market prices.