Investor sentiment, accounting information and stock price: Evidence from China

• We analyze the sentiment effect on stock price both theoretically and empirically.
• Sentiment affects price via the expected earnings growth and required rate of return.
• Investor sentiment has asymmetric effects on the channel variables and stock price.
• Accounting information explains the stock price well for stocks with stable earnings.
• Sentiment should receive more focus for stocks with high information uncertainties.

This paper analyzes the mechanism behind the effects of investor sentiment and accounting information on stock price based on the residual income valuation model. Using data from China's A-share market, we construct the sentiment index and examine the sentiment effect from the perspective of the expected earnings growth and the required rate of return. Furthermore, we investigate the joint effect of sentiment and accounting information on stock price and highlight the asymmetric effect of investor sentiment and the moderating effect of information uncertainty. The empirical results show that investor sentiment can change both the expected earnings growth and the required rate of return, thus affecting the stock price. However, the sentiment effect during pessimistic period is evidently different from that when sentiment is relatively high, especially for the required rate of return. In addition, accounting information and investor sentiment can both explain the stock price. However, accounting information is more reliable for stocks with stable earnings, whereas investor sentiment has evident asymmetric effect on stock price and should receive more focus for stocks with high information uncertainties.