Malcolm Baker and Jeffrey Wurgler pioneered sentiment beta a measure of sensitivity of a stock to investor sentiment that is particularly relevant in today's topsy-turvy markets.
The research takes a macroeconomic approach. It identifies which stocks are more sensitive to investor sentiment and which categories of stocks such as small-cap, growth, or companies under financial distress, Mr. Baker said. These stocks are difficult to value and arbitrage.
You might think of using investor sentiment ... as a way of refining a model for an investment strategy, said Mr. Baker, associate professor of finance at Harvard Business School, Boston. Together with Mr. Wurgler, research professor in finance at the Stern School of Business, New York University, they consult to Acadian Asset Management Inc.
Ronald D. Frashure, president, chief executive officer, and co-chief investment officer of Acadian Asset Management, declined to discuss the pair's work for Acadian because it is proprietary. He said, They are very valuable in our research.
The academics' work on investor sentiment has been noticed by other managers, too.
This type of work is important especially in today's markets, which has been characterized by wave after wave of investor sentiment the tech bubble, the bursting of the tech bubble, the housing bubble, the bursting of the housing bubble, the credit bubble and the bursting of the credit bubble, said Bruce I. Jacobs, principal at Jacobs Levy Equity Management Inc., Florham Park, N.J.
Wurgler and Baker's work doesn't attempt to find new irrational tendencies or biases, but looks at stock prices themselves for what they can tell us about behavioral quirks, Mr. Jacobs said.
In another area of research, Messrs. Baker and Wurgler found that new equity and debt issues are predictors of stock market returns. Corporations tend to issue more equity than debt just before periods of low market returns, while they tend to issue more debt than equity just before periods of high returns, Mr. Baker said, citing their research.
In the research, they present a theory of capital structure based on market timing.
When the stock market is overvalued, equity is a cheap source of capital, Mr. Baker said. And subsequent returns will be low because risk is low and mispriced.
This signal that predicts returns would be something investors could use for a portfolio strategy model, Mr. Baker said. So an investor might sell stocks when equity issuance is high and buy when debt issuance is high.Barry B. Burr