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We present evidence that consumer sentiment has a direct effect on excess aggregate stock returns. We also trace the source of this positive effect and find that public perception over the next year’s economic condition is the most important determinant for the stock market. Our findings remain conclusive even in the presence of other well known risk-based factors. The evidence thus supports behaviour finance theory that incorporates both psychological judgement and systematic risks. However, we do not find that past stock returns are influential on current sentiment nor do we find current sentiment Granger-cause subsequent stock return.


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