Investor sentiment and its nonlinear effect on stock returns-New evidence from the Chinese stock market based on panel quantile regression model

•We employ panel quantile regression model to examine investor sentiment-stock return relationship.•We investigate whether investor sentiment has a predictability on stock returns.•We verify whether investor sentiment has an effect on stock returns in Chinese stock market.•We find that investor sentiment can greatly lead to the stock mispricing in Chinese stock market.

This paper employs the panel quantile regression model to study the nonlinear effect of investor sentiment on monthly stock returns in the Chinese A-share stock market. The findings show that the influence of investor sentiment is significant from 1 month to 24 months. Its effect is asymmetric and reversal, that is, it is positive and large for stocks with high returns in the short term while negative and small in the long term. This reversal effect verifies the existence of a strong overreaction in the Chinese stock market. We also find that Chinese investors have notable cognitive bias and speculation tendency.