Institutional Investor Sentiment and the Mean-Variance Relationship: Global Evidence

Abstract

Although a cornerstone of traditional finance theory, empirical evidence in support of a positive mean-variance relation is far from conclusive, with the behavior of retail investors commonly thought to be one of the root causes of departures from this expected relationship. The behavior of institutional investors, conventionally thought to be sophisticated and rational, has recently come under closer scrutiny, including in relation to investor sentiment. Drawing together these two strands of literature, this paper examines the impact of institutional investor sentiment on the mean-variance relation in six regions, including Asia (excl. Japan), Eastern Europe, Eurozone, Japan, Latin America, and the US, and across thirtyeight markets. Empirical evidence supports the differential impact of institutional investor sentiment on the mean-variance relation (i.e., positive or negative), both across regions and across markets. In particular, for markets with cultural proneness to overreaction and a low level of market integrity institutional investor sentiment tends to distort the risk-return tradeoff.