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This study uses a modified present value framework to decompose the variance of returns of banks into the variance of contemporaneous expected returns and the variance of unexpected returns. The variance of unexpected returns accounts for most of the variance in total returns. When unexpected returns are decomposed into two components—cash-flow risk (fundamentals) and discount-rate risk (investor sentiment), cash-flow risk accounts for the major portion of unexplained risk, although discount-rate risk is also important. Moreover, the unexpected returns of banks fluctuate dramatically with changes in market conditions. In particular, the risk associated with cash-flow news is higher than the risk associated with discount-rate news during periods of economic expansion and easy monetary policy, while the variance of returns is more influenced by investor sentiments during periods of economic recession that are coupled with tightening monetary policies. Finally, the study shows that the relative importance of sentiment is higher for smaller banks than for larger ones.