Effect of Investor Sentiment on Market Response to Stock Split Announcement*

This paper creates monthly investor sentiment indices for Korea and provides evidence that these indices have the power to predict the subsequent 6-month buy-and-hold returns. In addition, the paper shows that investor sentiment positively affects market response to stock split announcements by using stock splits on the Korea Exchange from 1999 to 2006. First, market response to a stock split announcement is positively related to investor sentiment. Second, market response is more pronounced in high sentiment periods, particularly for small, young, highly volatile, and low profit-stocks, the valuations of which are highly subjective and difficult to arbitrage. Third, the initial effects of size, age, volatility, and profitability in times of high investor sentiment tend to be reversed over 12-month post-split performance. These empirical results imply that the market tends to overreact to stock split announcements for small, young, highly volatile, and low-profit firms in a high sentiment period but thereafter correct the overvaluation of those firms during the 12-month post-split performance. As such, the paper shows how investor sentiment affects the valuation of stocks at a corporate event level.