Behavioral Asset Pricing (sentiment premium)

[adidas4628]

Hello all, I just started reading. Please correct me if I am wrong on this, on schweser notes book 1 page 154, Behavioral Asset Pricing. It mentions Sentiment Premium and we can exploit it (arbitrage) if it’s systematic and predictable. My understanding is adding sentiment premium to discount rate leads to higher rate of return, lower expected value (intrinsic value) so we can make arbitrage by shorting the stock? Thank you for your explanation.

 

[ink]

You are right in saying that a sentiment premium leads to a higher required rate of return, so that when the value of the assets is discounted by that rate, the intrinsic value appears to be smaller relative to the scenario where the sentiment premium is ignored. An investor who considers the sentiment premium unwarranted, will consider valuation of investors who use the sentiment premium as underpricing the asset (since you get a smaller value). From the perspective of investors who ignore the sentiment premium, you shouldn’t short the stock; instead, you should use a buy-and-hold strategy because the intrinsic value should appreciate to the value given by the model without the sentiment premium.
On the other hand, investors who use the sentimennt premium will consider the valuation of investors who ignore it as overpricing the asset, and a shorting strategy would be appropriate.