A MODEL OF INVESTOR SENTIMENT

Recent empirical research in finance has uncovered two families of per vasive regularities: underreaction of stock prices to news such as ear nings announcements, and overreaction of stock prices to a series of g ood or bad news. In this paper, we present a parsimonious model of inv estor sentiment, or of how investors form beliefs, which is consistent with the empirical findings. The model is based on psychological evid ence and produces both underreaction and overreaction for a wide range of parameter values. (C) 1998 Elsevier Science S.A. All rights reserv ed.