Investor sentiment, credit rating, and stock returns

We confront the distress risk puzzle. Conventionally, stocks with high distress risk should yield higher returns. However, this notion is found to be empirically inaccurate. We develop a stock-level investor sentiment measure and find that behaviors of individual investors affect the future excess returns of stocks despite the presence of distress risk. Our findings suggest that net buying by individual investors enhances our understanding of the negative relationship between credit ratings and future stock returns. To do so, we develop a cross-sectional measure of the investor sentiment for each individual stock at each month.