Theoretical Research on the Impact of Investor Sentiment on Asset Pricing in Behavioral Finance

Abstract

This paper examines the impact and reasons of investor sentiment on asset pricing from the perspective of behavioral finance. Traditional finance holds that investors are rational and markets are efficient, but in reality, investors are influenced by various psychological factors such as cognitive biases and mood swings, which cause asset prices to deviate from their true value. This article, through a review of the relevant literature in behavioral finance, focuses on analyzing the generation process of investor sentiment, the way it spreads, and its impact on asset pricing. The research shows that investor sentiment affects asset pricing mainly in the following ways: First, it directly influences investors' risk appetite and investment decisions, thereby causing systematic bias in asset prices. Secondly, due to the herd effect and the contagion of sentiment, market volatility is further expanded, making asset prices even more unstable. Finally, under certain arbitrage constraints, mispricing caused by sentiment can persist for a long time. This paper presents a theoretical framework of how investor sentiment affects asset pricing, analyzes the reasons why optimism leads to asset overvaluation and pessimism leads to asset undervaluation, and also discusses the role of sentiment factors in intertemporal asset pricing models. The results show that investor sentiment not only affects short-term fluctuations in asset prices, but is also an important factor in explaining long-term yield anomalies. Asset pricing models that incorporate sentiment factors can better explain market anomalies and are of great significance to investment practice and risk management. This paper enriches the theoretical framework of behavioral finance and helps to understand the complexity of financial markets and the irrational behavior of investors.