Investor Sentiment, Disagreement, and the Breadth-Return Relationship

We study the cross-sectional breadth-return relation by assuming that investors subject to market sentiment hold a biased belief in the aggregate. With a dynamic multiasset model, we predict that the breadth-return relationship can be either positive or negative depending on the relative strength of two offsetting forces-disagreement and sentiment. We find evidence consistent with our predictions. The breadth-return relationship is positive when the sentiment effect is small. However, the relationship becomes negative when (i) the time-series variation of market-wide sentiment is high and (ii) the cross-sectional dispersion of firm-specific exposure to market-wide sentiment variation is large. Our unified framework reconciles a few seemingly inconsistent empirical studies in this literature and explains puzzling cross-sectional return patterns observed during the Internet bubble and the subprime crisis periods.