Investor Sentiment, Limits to Arbitrage and Private Market Returns



This article examines the relation between investor sentiment and returns in private markets. Relative to more liquid public markets, private investment markets exhibit significant limits to arbitrage that restrict an investor's ability to counteract mispricing. Using vector autoregressive models, we find a positive and economically significant relation between investor sentiment and subsequent private market returns. We provide further long-horizon regression evidence suggesting that private commercial real estate markets are susceptible to prolonged periods of sentiment-induced mispricing as the inability to short-sell in periods of overvaluation and restricted access to credit in periods of undervaluation prevents arbitrageurs from entering the market.