Investor sentiment and aggregate volatility pricing

• Aggregate volatility is a priced risk factor only during low sentiment periods.
• In high sentiment periods, the relation between aggregate volatility risk and expected returns is undermined.
• The role of investor sentiment in the pricing of aggregate volatility risk is robust to various controls.

This paper aims at providing new insights on the pricing of aggregate volatility risk by incorporating investor sentiment in the relation between sensitivity to innovations in implied market volatility and expected stock returns. Using both cross-sectional and time series analysis, we investigate the effect of the exposure to aggregate volatility risk on stock returns in both high-sentiment and low-sentiment regimes. We find that exposure to aggregate volatility risk is negatively related to returns when sentiment is low. However, this relation loses its significance when sentiment is high. The documented negative relation is robust to controls for other variables and to the use of various sentiment proxies, suggesting that aggregate volatility risk is an independent risk factor only during low sentiment periods.