Does “Sentiment Beta” beget “Sentimental Alpha”?
May 14th, 2008 | Filed under: CAPM / Alpha TheoryPensions & Investments published a special report earlier this week on the increasingly important role played by academics in today’s world of investment management. It contains a series of articles on the plethora of professors who augment their modest academic salaries with (lucrative) consulting gigs for asset managers. One of the articles in the report that caught our eye was about Malcolm Baker of Harvard and Jeffrey Wurgler of NYU. The duo has been writing about behavioral finance for several years.
Behavioral finance has often been touted as the successor to the CAPM since it aims to explain how the grand old model doesn’t hold up under empirical analysis. Unfortunately, behavioral finance has so far lacked a unifying theory of its own capable of galvanizing the field of finance. Still, Baker and Wurgler borrow from the lexicon of the CAPM to propose a measure they call “Sentiment Beta”.
As P&I points out, some big names have taken notice. Bruce Jacobs of Jacobs, Levy tells the newspaper:
“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…
At first blush, “sentiment beta” sounds kind of redundant. After all, doesn’t beta itself capture market sentiment? If sentiment rises, the market rises. And if the market rises, high-beta stocks rise anyway, right?
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