Sentiment volatility and financial constraints in stock returns

Abstract This article examines how sentiment volatility, changes in the magnitude of sentiment, impacts financially constrained firms' stock returns across varying economic conditions. Using a sentiment measure derived from economic news, the analysis shows that higher sentiment volatility is associated with lower stock returns. Financially constrained firms typically earn higher returns, but their returns are limited when sentiment volatility increases. During optimistic periods, higher sentiment volatility leads to increased stock returns for constrained firms, reflecting improved investor confidence. In contrast, during pessimistic periods, these firms experience more pronounced declines in returns due to heightened risk and macroeconomic uncertainty.