Edited by Lawrence R. Klein
Chapter 12: Using Sentiment Surveys to Predict GDP Growth and Stock Returns
1 Giselle Guzmán 1. INTRODUCTION The American Heritage Dictionary defines ‘sentiment’ as ‘a thought, view, or attitude, especially one based mainly on emotion instead of reason.’ By the same token, it defines something that is ‘not endowed with reason’ to be ‘irrational.’ Hence, ‘sentiment’ is largely regarded as ‘emotional’ and ‘irrational.’ Classical asset pricing theory makes no provision for such an irrational component in determining asset prices, particularly in long-run equilibrium. Yet it remains a favorite statistic for financial media and popular press, and is the source of endless commentary by market pundits and economists alike. Indeed, the financial press often credits or blames ‘sentiment’ for a rising or falling stock market. If markets do, in fact, react to reports of changes in sentiment, then this indicates that the reality of asset pricing contradicts the theory of asset pricing. This suggests an oversight on the part of the academic literature in failing to give sentiment the importance it may warrant in the theory of asset pricing. Academics have only recently begun to examine what role, if any, sentiment may have in the theory of asset pricing. However, consensus is lacking regarding its most basic characteristics. The literature remains divided not only about whether or not sentiment matters for asset prices, but also about what sentiment actually is, and how best to measure and incorporate it in a theoretical framework. I focus here on the empirical aspects of sentiment, its measurement and its predictive power for the real economy as...
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