ASSET PRICING WITH INVESTOR SENTIMENT: EVIDENCE FROM CHINESE STOCK MARKETS*

We study the impact of investor sentiment on stock returns in China, using as a benchmark the three-factor Fama–French model, and distinguishing between normal and positive sentiment. Sentiment helps explain the mis-pricing component of returns in the Fama–French model and the time variation in the factors themselves. Factor loading patterns noted by Fama-French are evident in China, but they can be equally well modelled by sentimental factors. Fama–French factors are less significant if factors are conditioned by sentiment, suggesting that in China sentiment affects both the way investors judge risks as well as portfolio returns directly.