Analysis of the Pricing Capability of the Expanded Fama-French Five-Factor Model Based on Investor Sentiment

Yuliang Li

doi:10.54097/00p86p27

Authors

Yuliang Li Stirling College, Chengdu University, Chengdu, 610106, China

DOI:

https://doi.org/10.54097/00p86p27

Keywords:

A-share Market, Investor Sentiment, Fama-French Five-Factor Model, Asset Pricing, Behavioral Finance.

Abstract

The Chinese A-share market has a distinctive market ecosystem, with retail investors accounting for over 99%. Their unique trading behaviors significantly influence market liquidity and the formation mechanism of prices. Meanwhile, traditional asset pricing models have limitations when applied in emerging markets, and they are unable to explain abnormal returns caused by investors' irrational behaviors. This paper constructs an investor sentiment factor based on market trading behaviors, technical indicators, and alternative data, and extends the Fama-French five-factor model. Three methods, namely time series regression, GRS test, and Fama-MacBeth cross-sectional regression, are used to test the model. The results show that the investor sentiment factor has stable pricing ability in the emerging market environment with a high proportion of retail investors and significant sentiment fluctuations. It effectively explains abnormal returns that traditional models fail to capture. Additionally, institutional investors can use the sentiment factor to optimize investment portfolios and risk management, while individual investors can reduce irrational investments based on it. Regulatory authorities can also build a market monitoring system to prevent systemic risks.

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