Essays on the Impact of Stakeholders' Sentiment on the Financial Decision Making Process

The most important factor that affects the decision making process in finance is the risk which is usually measured by variance (total risk) or systematic risk (beta). Since investors' sentiment (whether she is an optimist or pessimist) plays a very important role in the choice of beta measure, any decision made for the same asset within the same time horizon will be different for different individuals. In other words, there will neither be homogeneity of beliefs nor the rational expectation prevalent in the market due to behavioral traits. This dissertation consists of three essays. In the first essay, Investor Sentiment and Intrinsic Stock Prices, a new technical trading strategy is developed using a firm specific individual sentiment measure. This behavioral based trading strategy forecasts a range within which a stock price moves in a particular period and can be used for stock trading. Results show that sample firms trade within a range and show signals as to when to buy or sell. The second essay, Managerial Sentiment and the Value of the Firm, examines the effect of managerial sentiment on the project selection process using net present value criterion and also effect of managerial sentiment on the value of firm. Findings show that high sentiment and low sentiment managers obtain different values for the same firm before and after the acceptance of a project. The last essay, Investor Sentiment and Optimal Portfolio Selection, analyzes how the investor sentiment affects the nature and composition of the optimal portfolio as well as the performance measures. Results suggest that the choice of the investor sentiment completely changes the portfolio composition, i.e., the high sentiment investor will have a completely different choice of assets in the portfolio in comparison with the low sentiment investor. The results indicate the practical application of behavioral model based technical indicators for stock trading. Additional insights developed include the valuation of firms with a behavioral component and the importance of distinguishing portfolio performance based on sentiment factors.