How Will Irrational Investor Sentiment Affect CAPM

Abstract

China's capital market started late and is not as mature as compared to Europe and the US. China's stock market contains many anomalies, such as scale effects, illiquidity premiums, etc. These phenomena cannot be well explained by the traditional CAPM. For this reason, we need to modify the CAPM by writing the beta as a function influenced by investor sentiment, macro indicators, economic uncertainty and other factors. The empirical results show that the value anomalies that are not explained by the traditional model are covered by the CAPM when adjusted for investor sentiment, and become less significant. This suggests that investor sentiment is an important influencing factor in the stock market, at least in China. This is probably due to the large number of individual investors in China and the fact that the securities market is more closely linked to government policy.