Stock-level sentiment contagion and the cross-section of stock returns

•We study contagion effect of stock-level sentiment in Chinese Stock Markets.•Stock-level sentiment co-moves and spreads in different individual stocks and industrials.•Stock-level sentiment contagion has a systematic influence on cross-section of stock returns.•Stock-level sentiment contagion decreases as the information quality improves.•Stock-level sentiment contagion effects are positively correlated with economic policy uncertainty. As investor sentiment can be cross-sectionally heterogeneous and contagious across different assets, stock-level investor sentiment may also be contagious among different stocks. This study provides empirical evidence on the patterns of stock-level sentiment contagion among different stocks and its roles on the cross-section of stock returns in the Chinese Stock Markets. Firstly, we found significant stock-level sentiment contagion effects by capturing the contagion patterns of investors’ psychological and heterogeneous beliefs across different stocks and industries. Secondly, stock-level sentiment contagion has a systematic and positive impact on the cross-section of daily stock returns. Thirdly, stock-level sentiment contagion effects are stronger for stock portfolios with small size, high volatility, growth, young and low fixed asset ratios. Furthermore, the quality of firm-specific information and the strength of economic policy uncertainty have different effects on stock-level sentiment contagion. Collectively, this study provides direct evidence for the cross-section of stock returns from the perspective of sentiment contagion.