Market Uncertainty, Investor Sentiment, and the Beta Premium

ABSTRACT

This paper provides new insights into how time‐variation in the beta premium is related to popular measures of market uncertainty and sentiment; specifically, the CBOE's VIX and the sentiment index of Baker‐Wurgler (2006). We show that the beta premium: (1) increases nonlinearly with uncertainty, rising significantly only when VIX exceeds a critical threshold around its 80th to 85th percentile; and (2) decreases linearly with sentiment. Over our 1990 to 2023 sample, the predictive results of our parsimonious two‐term model are robust across multiple horizons (1‐, 3‐, 6‐, and 12‐month), for both equal‐weighted and value‐weighted beta‐premia, when analyzing both overlapping and nonoverlapping returns, in both subperiod and out‐of‐sample evaluations, and in the betting‐against‐beta position of Frazzini and Pedersen (2014). Our risk‐based interpretation is that VIX and sentiment jointly capture well both the level of risk and the price of risk.