Investor trading behavior, investor sentiment and asset prices

•Both investor trading behavior and investor sentiment have significant effects on excess returns.•Investor trading behavior has more significant impacts on excess returns than investor sentiment.•Investor trading behavior and investor sentiment have greater effects on small stocks.•We examine the term structure of investor sentiment effect and investor trading behavior effect.

This paper examines the roles of investor trading behavior and investor sentiment on asset prices. We find that both the investor trading behavior and investor sentiment have significant effects on excess returns beyond the three factors of Fama and French (1993), and more importantly, the investor trading behavior has more significant impacts on excess returns than investor sentiment. Furthermore, the empirical results reveal that the impacts of investor trading behavior and investor sentiment on the excess returns of small stocks are greater than large stocks, which is failure to explain small stock returns in Fama and French, 1993, Fama and French, 2012 and Fama and French, 2015. Moreover, this paper demonstrates the term structure of investor sentiment effect and the term structure of investor trading behavior effect. Collectively, our findings support the roles of investor trading behavior and investor sentiment on the formation of excess returns.