The sentiment represents the anticipations of the investors that are not justified by the fundamental.
The notion of sentiment characterizes the presence of irrational investors who show undue interest in an investment opportunity, for example for IPOs, and who are irrationally exuberant, over optimistic and over enthusiastic about an investment. This over optimism and over enthusiasm is not justified by fundamental. Or on the contrary, these investors are over pessimistic and they are much dissuaded about the issues with any reason or relevant justification. All the decisions are conducted by sentiments and feelings.
An optimistic investor (pessimistic) expects returns that are higher (lower) to those that could be explained by the fundamental indicators. In other words, the sentiment can be defined by the fact that the investor is optimistic (pessimistic) without having good (bad) economic reasons for the being.
The sentiment felt by the investor is very complicated and very hard to surround, since there are numerous biases that can have an impact on the investor behaviour. The sentiment also differs from an investor to another, it is individual and can not be foreseen. It depends on the investor’s personality, his beliefs, his thoughts…
Biases have been studied by psychologists for some time and financial economists have recently introduced them into formal models of asset pricing. For example, a large literature reports that people believe their knowledge to be more accurate than it really is (Odean (1998)), and then they overweight the information collected by themselves and underweight the information collected by the others. In the same direction, Kaustia and Knupfer (2008) on a sample of 57 Finnish IPOs from January 1995 through December 2000, study the link between past personally experienced outcomes and future IPO subscriptions. They find that personally experienced outcomes have a greater effect on behaviour and on future IPO subscriptions, than, say just reading about the same information without personal involvement. When deciding to subscript in IPOs, investors overweight their personal experience more than the information collected by the other investors, which goes in the same direction as believing in their knowledge and in their own information.
However, there are other possible reasons for systematic decision errors. In a recent review, Hirshleifer (2001) argues that many or most familiar psychological biases can be viewed as outgrowths of heuristic simplification (an imperfect decision making procedure that makes people have reasonably good decision cheaply). We can also talk about framing effects (wherein the description of a situation affects judgments and choices), money illusion (wherein nominal prices affect perceptions), and mental accounting (tracking gains and losses relative to arbitrary reference points).
We also find overconfidence (a tendency to overestimate ones ability or judgment accuracy) which may be due to another bias “self attribution”. Experiments have shown that people tend to attribute favourable outcomes to their abilities and unfavourable ones and failure to chance or other external factors beyond their control (Daniel, Hirshleifer, and Subrahmanyam (1998)). This bias is known as “self attribution” and may even be at the origin of “overconfidence”.
This list of biases is not exhaustive and can be very long.
These psychological biases have a great effect on the sentiment, and they also differ from an investor to another making the sentiment a very complicated notion hard to surround or to foresee.
The IPO market presents an environment which is more prone to investor sentiment and where irrational investors are more likely to exist, since IPO firms by definition have no prior share price history and tend to be young, immature, and relatively informationally opaque.
Not surprisingly, therefore, these firms are hard to value, and it seems reasonable to assume that investors will have a wide range of beliefs and feelings about their market values. Investors will be very influenced by feelings and emotions in valuing the IPO and in deciding whether to invest in.