A Survey of the Literature on the Investor Sentiment and Its Role in Asset Pricing -- A Focus on Equity Market Return

This research mainly focuses on the crucial role of investor sentiment in the changes of asset pricing, especially its influence on risk arbitrage and market behavior. We know that both behavioral finance theory and empirical evidence are of great significance. The research combines them to see how investor biases, such as being overly optimistic or pessimistic, cause asset pricing errors and make the market unstable. To study this, we used some widely recognized sentiment indicators, such as the AAII Sentiment Survey, the VIX (Volatility Index), and the Composite Sentiment Index. Through these indicators, we examined the relationship between irrational investor behavior and pricing anomalies. The outcomes demonstrate the distinctively substantial impact that investor sentiment wields on risk arbitrage techniques, especially during market events like mergers and acquisitions. When speculative sentiment takes hold, people tend to overreact, leading to incorrect asset pricing. Moreover, the research also indicates that when investor sentiment is low, stocks with small size, short establishment time, and high volatility actually have higher returns. This suggests that sentiment is helpful for predicting stock returns. We added the sentiment indicators to the traditional asset pricing model, which enables us to better understand market changes and optimize risk arbitrage strategies. In conclusion, the research results tell us that considering the perspective of behavioral finance is very important when conducting financial analysis. This can provide useful methods for investors and policymakers to deal with market problems caused by investor sentiment.