In this paper, we experiment with alternative investor sentiment indices and their construction methodologies. We further evaluate the role of sentiment based factor in asset pricing to explain prominent equity market anomalies in India. The findings confirm that our composite sentiment index leads market performance. It also appears to be a better sentiment measure than those currently in vogue in the investment literature. Three prominent equity market anomalies namely size, value, and price momentum are verified and confirmed for India, and the empirical results seem to be robust for alternative portfolio formations. The Fama French 3 factor model performs well in explaining asset returns for different portfolio formations, with a few exceptions. We further show that the new Fama French 5 factor model is able to capture returns on some of the unexplained portfolios, while returns on other portfolios are explained by our sentiment factor. Our sentiment based factor seems to proxy for the price over-reactions. We thus confirm the role of sentiment factor in asset pricing especially for small stock portfolios. The findings are pertinent for global investors, policymakers as well as the academic community. The study contributes to asset pricing and behavioural finance literature for emerging markets like India.
