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How Does Investor Sentiment Affect Stock Market Crises? Evidence from Panel Data

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Abstract

We test the impact of investor sentiment on a panel of international stock markets. Specifically, we examine the influence of investor sentiment on the probability of stock market crises. We find that investor sentiment increases the probability of occurrence of stock market crises within a one-year horizon. The impact of investor sentiment on stock markets is more pronounced in countries that are culturally more prone to herd-like behavior, overreaction and low institutional involvement.

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... On the other hand, the financial literature has found that the economic and regulatory environment affects performance as a result of the institutional quality and corporate governance of companies [28], the level of legal institutions and economic development [29], the level of integration and development of financial markets [11,30] and cultural differences [31]. The sample selection is, for this reason, a factor that can condition the results of the study on the relationship between investor sentiment and financial asset price behavior. ...
... A second approach is to develop indexes using investor surveys [42]. There are several relevant indexes for the US market: University of Michigan Consumer Sentiment Index (a monthly index calculated from a consumer confidence survey of a random group of five hundred American households) [10,30,[43][44][45][46][47]; the American Association of Individual Investor sentiment survey (an index that provides weekly information on the bullish, bearish or neutral perception of a pool of financial market surveys over the next six months) [6,19,[48][49][50][51][52]; and the Investor Intelligence and Daily Sentiment Index (an index that determines the balance between bull and bear investors) [53]. In the case of the European Union, the European Commission's monthly consumer confidence indicator has been used [54]. ...
... A final key element is the size of the investor whose sentiment is analyzed [37]. There is no consensus: some studies find there is a relationship between small investor sentiment and market prices [7,28,30,[43][44][45]48,50,[73][74][75] and others [6,54,70,76] conclude that there is no significant relationship between retail investor sentiment and market returns, even finding that the explanatory power is in the opposite direction, that is, returns and volatility variations affect sentiment, not the other way around. ...
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A part of the financial literature has attempted to explain idiosyncratic asset shocks through investor behavior in response to company news and events. As a result, there has been an increase in the development of different investor sentiment measurements. This paper analyses whether the Bloomberg investor sentiment index has a causal relationship with the abnormal returns and volume shocks of major European Union (EU) financial companies through a sample of 85 financial institutions over 4 years (2014–2018) on a daily basis. The i.i.d. shocks are obtained from a factorial asset pricing model and ARMA-GARCH-type process; then we checked whether there is both individual and joint causality between the standardized residuals. The results show that the explanatory capacity of the shocks of the firm Bloomberg sentiment index is low, although there is empirical evidence that the effects correspond more to the situation of the financial subsector (banks, real estate, financial services and insurance) than to the company itself, with which we conclude that the sentiment index analyzed reflects a sectorial effect more than individual one.
... Consideration of investment sentiment is important; however, it can be useful in forecasting crises in general and relative to different economic sectors (Zouaoui et al., 2011;Uygur & Tas, 2014). The perception of risk comes with negative market sentiments and can lead to investor panic (Gang et al., 2019;Golić, 2019). ...
... Investor sentiment on stock markets is pronounced in environments with herd-like behavior, overreaction, and institutions' minimal involvement. Positive or negative news can result in significant optimism or pessimism with investors affecting asset prices over a significant period (Zouaoui et al., 2011). Investor systematic biases and beliefs result in them exhibiting normal rather than rational behavior and trade in the stock market across sectors based on nonfundamental information (Zouaoui et al. 2011). ...
... Positive or negative news can result in significant optimism or pessimism with investors affecting asset prices over a significant period (Zouaoui et al., 2011). Investor systematic biases and beliefs result in them exhibiting normal rather than rational behavior and trade in the stock market across sectors based on nonfundamental information (Zouaoui et al. 2011). Investor sentiment in the presence of news and the attempt to diversify across sectors supports the importance of examining whether stocks directly correlate to their assigned sector or whether performance varies in line with news releases. ...
Article
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The purpose of this correlational study is to examine the change in stock performance relative to the stock’s assigned sector and the NYSE index in the presence and absence of news. This quantitative study examines whether stocks directly correlate to their assigned sector or whether performance varies in line with news releases. The data selection process included applying specific parameters to identify a proportion of the New York Stock Exchange (NYSE) population listed stocks selected from five of the 11 sectors. The individual stock, sector, and NYSE market data and news related to the population of stocks were collected from publicly available sources for four specific periods in 2018 identified by high and low volatility using the Chicago Board Options Exchange Volatility Index. The news was assessed in a sentiment analyzer to qualify stories as positive, neutral, or negative. A two-tailed multiple regression analysis was performed to identify statistically significant performance changes due to the presence or absence of news, and a performance prediction of the affected stocks was performed against the assigned sector and overall market. Keywords: Correlation, Volatility Index, Statistically Significant, Market Sector, Stock, Regression Analysis, and t-test.
... In this regard, Pesaran (2006) shows that failure to address this problem could probably result in biased parameter estimates and misleading inference. Therefore, unlike the handful of relevant panel data-based papers overlooking the possibility of error cross-sectional dependencies (e.g., Aristei and Martelli, 2014;Schmeling, 2009;Zhang et al., 2019a,b;Zouaoui et al., 2011), the current work accounts for such a possibility by adopting the Common Correlated Effects (CCE) estimation procedure for dynamic heterogeneous panel data models. This approach is proposed by Pesaran (2006) and further developed by Chudik and Pesaran (2015). ...
... Swamy et al. (2019) establish that higher levels of investor attention, proxied by the Google Search Volume Index (GSVI), predicts positive returns on the Bombay Stock Exchange for the next two weeks. Based on a sample of 16 developed and developing countries, Zouaoui et al. (2011) document a strong positive influence of consumer confidence, as a proxy for investor sentiment, on the probability of stock market crises. The influence is more obvious in countries with poor institutional involvement, herd-like investment behavior, and overreaction. ...
Article
This study sets out to explore the effects of business and consumer sentiment on stock market performance, within the separate contexts of advanced and emerging markets. The empirical analysis is carried out using the cross-sectionally augmented autoregressive distributed lag (CS-ARDL) modeling approach, which considers time dynamics, cross-sectional heterogeneity, and cross-sectional dependence. The findings for developed markets suggest that business sentiment has positive leading effects on stock returns, across short- and long-term time horizons, while for emerging markets, the price impact of business sentiment turns out to be short-lived. On the other hand, consumer sentiment tends to affect positively both market types, albeit only in the short run. Furthermore, the influence of sentiment indicators seems to be stronger in emerging- than in developed-market countries. The results remain robust, even after controlling for a rich range of potential predictors of stock returns. Generally, such evidence highlights the relevance of psychological factors, such as business and consumer sentiment, in determining the future trajectory of asset prices.
... Lucia & B.A.O (2012), the global stock market becomes more and more dependent, and the crisis in 1 country will soon spread other countries. Zouaoui (2011), in countries that culturally more susceptible to herd activities also overreactions or country with low institutional participation, investor sentiment has a more obvious impact on the stock market. ...
... Events such as the outbreak from infectious diseases may trigger negative change investor sentiment, greatly affectly their investments decicions, also cause stocks market price to rise (Donadelli, 2016). In country that culturally more susceptible obvious action and reactions of livestock groups or country with low institutional participation and investor sentiment has a more obvious impact on the market (Zouaoui, 2011). ...
Article
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p>This research was conducted to determine the impact of Covid-19 on the Company’s stock returns and trading volume activity. The covid-19 pandemic event is important for research because it includes investor’s assessment of the information generated in the capital market. This study was conducted to test the following hypotheses: before and after the Covid-19 pandemic was declared a national non-natural disaster, (1) there was a significant average change in the average abnormal return; (2) it is a significant average change in average trading volume activity. This research was conducted using event research methods. The sample for this study comes from 45 companies in the JII index. The analysis tool used is a regression with the SPSS. The descriptive statistic can be confirmed by calculating the standard deviation value. The result shows that the standard deviation range is 0.0002 to 0.03, so the research tool could be described as data obtained is suitable to the measurement variable. The conclusions explain that the events before and after the declaration of the Covid-19 outbreak as a national non-natural disaster have positive and a significant impact on the average abnormal return rate of stock activity and changes in trading volume activity.</p
... Han and Li's (2017) OOS analysis uses the R 2 of Campbell and Thompson (2008), the MSFE test statistic of Diebold and Mariano (1995), and the MSFEadjusted test statistic of Clark and West (2007). Zouaoui et al. (2011) consider the following four metrics for OOS analysis: the OOS R 2 , the root mean-squared error, the mean absolute error, and Theil's U-statistic. The OOS analysis of Huang et al. (2015) uses Campbell and Thompson's (2008) R 2 statistic, Diebold and Mariano's (1995) t-statistic as modified by McCracken (2007), and Clark and West's (2007) MSFE-adjusted statistic. ...
... When sentiment runs high, these patterns are reversed. Zouaoui et al. (2011) use the consumer sentiment index for several European countries and find that investor sentiment increases the probability of stock market crises within a one-year (2) and (3), respectively, and EURsent is the sentiment index. The series for the cash flow news, and discount rate news are estimated using the first-order VAR approach for each of the 362 firms in the S&P 350. ...
Article
This study presents a new European investor sentiment index, EURsent, based on new individual sentiment proxies such as VSTOXX, gold, and the German bond yield spread, and studies the spillover and contagion between the United States and Europe. Furthermore, it analyses the simultaneous influence of this new sentiment measure index on both volatility and stock returns, including causality. Applying well-established statistical techniques, such as principal component analysis, ordinary least squares, autoregressive conditional heteroskedasticity (ARCH), generalized ARCH (GARCH), and threshold GARCH models, the findings demonstrate how EURsent is closely interrelated with the most universally recognized sentiment index in academia, demonstrating strong co-movement between the US and European stock markets, mainly prior to the global subprime crisis. The study also applies vector autoregressive modelling and OOS analysis that allows one to conclude that EURsent is a strong predictor of market returns, through the discount rate and cash flow news, although the latter is the most relevant channel. This study creates a truly representative measure of global European investor sentiment that is comparable to that created by Baker and Wurgler for the United States, interlinking a holistic sentiment measure index, sustained on new single investor sentiment proxies, with conditionally market volatility and market returns, suggesting causality. EURsent could thus be a tool for investment managers, investors, and financial service providers as well as regulators to monitor the evolution of stock markets.
... Bayram (2017) uses rational and irrational consumer and business sentiment, and reports that both influence the returns of the stocks listed on the ISE. Zouaoui et al. (2010) use panel data of 15 European and the U.S. stock markets and find that sentiment has more effect on stock returns in those countries where investors are prone to herd behavior and institutional investment is relatively low. Grigaliuniene and Cibulskiene (2010) examine the effect of sentiment in Scandinavian markets and report an inverse relationship between sentiment and future stock returns. ...
Article
Since frontier markets are dominated by less-informed individual investors, stock price movements of these markets could be related to the sentiment of general investors. This paper investigates the effect of sentiment on the returns of the Dhaka Stock Exchange (DSE), the main stock exchange in Bangladesh. This study uses indirect measures of stock market sentiment. Results show that sentiment impacts contemporaneous returns followed by some corrections in the next month. Contrary to general belief, large firms are more vulnerable to market sentiment. There is a unidirectional (Granger) causality from market turnover to portfolio returns and a strong bi-directional causal relationship between moving average changes and stock returns. When conditional volatility is considered, significant impact of sentiment is mainly observed for small size portfolios. In the presence of other market-wide risk factors, sentiment factors reasonably explain individual stock returns. Overall, in the context of the DSE, the study concludes that sentiment should be considered as a source of systematic risk.
... These investors buy at low prices, select high growth stocks and stocks that pay high dividends, and decide upcoming positive stock market earnings. This conclusion is also understated by Wurgler (2006, 2007) for the American market, and Zouaoui et al. (2011) for some European countries using consumer sentiment as sentiment proxy. Also, Papapostolou et al. (2016) support the significance of supertanker industry sentiment as a contrarian global predictor of financial assets in both in-sample and out-of-sample frameworks. ...
Article
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This paper proposes an Investor Sentiment Index for the European market and tests its predictability power over returns and volatility. The constructed Investor Sentiment Index for Europe draws upon three well-established and two recent individual sentiment proxies through a novel dynamic factor modeling addressed to behavioral finance. The index is obtained through an extended period of analysis and validated with other sentiment index measures. The work relies on individual sentiment proxies based on a dynamic factor model and tests it using a TGARCH model for volatility and returns. It carries out an in-sample and out-of-sample analysis to examine this sentiment index’s forecasting power over returns sustained on a recursive rolling window prediction against Fama and French’s three-factor model. The findings demonstrate that the proposed index closely predicts STOXX600 variance and returns and confirms a strong spillover effect between European and US stock markets. This study also concludes that the proposed European Sentiment Index is a valid alternative method for investors to monitor and predict market behaviors. The developed sentiment measure is a vital market prediction movement tool for financial information providers, investors, bankers, and financial analysts. The research combines the sentiment index with a TGARCH approach over the extended period of analysis and validates the method with other sentiment index measures. An in-sample and out-of-sample study confirms the predictive power of this work’s sentiment over returns compared to Fama and French’s three-factor model. AcknowledgmentThis work is funded by National Funds through the FCT – Foundation for Science and Technology, I.P., within the scope of the project Refª UIDB/05583/2020. Furthermore, we would like to thank the Research Centre in Digital Services (CISeD) and the Polytechnic of Viseu for their support.
... These results are revealing and are in line with the behavioral school, which suggests that over pessimism of investors can have a persistent impact and affect stock prices for significant periods of time. (Zouaoui et al., 2011). We also examine the impact of COVID-19 sentiment on the highly liquid exchange-traded funds. ...
Article
Purpose The purpose of this paper is to capture the investors' mood related to the COVID-19 pandemic and analyze its impact on the stock market returns. Design/methodology/approach To capture the investor mood related to the COVID-19 pandemic, the authors construct a unique COVID-19 fear index based on the Search Volume Index (SVI) from Google Trends (http://www.Google.com/trends/) of the search terms related to COVID-19 words and phrases as revealed by Google and Internet dictionaries. The COVID-19 fear index was used to investigate its impact on the stock market returns. Findings The study finds a strong negative association between COVID-19 fear and stock returns. Unlike other studies, the relationship is persistent for a significant period. This relationship is not found to reverse in the following days. The results also highlight that COVID-19 fear strongly impacts the stock market. The sentiment persists for a significant period and is not reversed soon, unlike the regular times in earlier studies. Originality/value The study is among the very few studies that constructed COVID-19 fear index using several Google search terms and captured its impact on the stock market returns.
... In contrast, in a low sentiment period, the stock price sensitivity behaves negatively. As per analysis suggestions, the investor sentiment becomes the reason for the general mispricing of stock because of sentient-driven mispricing of earning contributions (Schmeling, 2009;Zouaoui et al., 2011;Mian and Sankaraguruswamy, 2012;Cheema et al., 2020). The high market competition indicated that sentiments and returns are positively related to each other, and this relationship disappears in low market competition. ...
Article
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A highly transmittable and pathogenic viral infection, COVID-19, has dramatically changed the world with a tragically large number of human lives being lost. The epidemic has created psychological resilience and unbearable psychological pressure among patients and health professionals. The objective of this study is to analyze investor psychology and stock market behavior during COVID-19. The psychological behavior of investors, whether positive or negative, toward the stock market can change the picture of the economy. This research explores Shanghai, Nikkei 225, and Dow Jones stock markets from January 20, 2020, to April 27, 2020, by employing principal component analysis. The results showed that investor psychology was negatively related to three selected stock markets under psychological resilience and pandemic pressure. The negative emotions and pessimism urge investors to cease financial investment in the stock market, and consequently, the stock market returns decreased. In a deadly pandemic, the masses were more concerned about their lives and livelihood and less about wealth and leisure. This research contributes to the literature gap of investors’ psychological behavior during a pandemic outbreak. The study suggests that policy-makers should design a plan to fight against COVID-19. The government should manage the health sector’s budget to overcome future crises.
... Furthermore, there are already a number of studies that have examined many countries, mostly developed markets, as panel datasets (e.g., (Chung et al. 2012;Fernandes et al. 2013;Uygur and Taş 2014;Zaremba et al. 2020;Zouaoui et al. 2011)). There are two main reasons why this study focuses on share markets in Australia and New Zealand (NZ). ...
Article
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Investor sentiment is an important aspect of behavioural finance, which provides explanation of anomalies to the asset’s intrinsic values. Sentiments can easily affect individual investors. Historically, Australia is regarded as rich in resources but poor in capital, and this motivates the paper to further study and compare the effects of investor sentiment on performance returns. Aggregate and cross-sectional effects, as well as predictive regression analysis to forecast the relationships, while controlling for the macroeconomic variables, are used by employing Consumer Confidence Index (CCI) and trade volume as sentiment proxies. Contrary to some studies with aggregate stock markets, it is discovered that in the short term, investor sentiment poses a positive impact with strong predictive power on the forecast of portfolio returns but not so much in the long run, which supports the classical theories of rational investors. In both Australian and New Zealand markets, the sentiment proxies also cannot predict the returns portfolios with dividends in the long/short portfolio and book-to-market ratio long/short portfolio.
... Investor sentiment easily promotes Bitcoin price compared to basic economic factors (Baek & Elbeck, 2015). Zouaoui et al. (2011) evidence that the financial market involving fewer institutional investors participation are more sensitive to sentiment swings. Compared with mainstream asset classes, the Bitcoin market is still in its infancy, with lower liquidity, higher transaction costs, and lower participation by institutional investors (Kharpal, 2017;Shevchenko & Godwin, 2018). ...
Article
This paper explores how fear sentiment affects the price of Bitcoin by employing the rolling-window Granger causality tests. The analysis reveals negative influences from the volatility index (VIX) to Bitcoin price (BTC), which ascertains that Bitcoin can not be considered a haven in fear sentiment. Due to the liquidity in economic downside risks, BTC may decrease with high VIX to hedge losses, increasing during low VIX periods. The empirical results conflict with the intertemporal capital asset pricing model, which underlines that the increasing VIX can promote the price of Bitcoin. In turn, BTC positively impacts VIX, which shows that Bitcoin price can be treated as the main indicator for a more comprehensive analysis of the fear index. Under severe global uncertainty and changeable fluctuation of market sentiment, investors can optimize investment decisions based on market fear sentiment. The government can also consider VIX to grasp the trend of BTC to participate in cryptocurrency speculation effectively. First published online 18 January 2022
... Morales and Callaghan (2012) reported that due to globalization, markets are becoming interdependent, and disaster in one country is likely to affect other connected countries as well. Donadelli et al. (2017) and Zouaoui et al. (2011) documented that the impact of a disease outbreak on an investor's sentiment is more prominent in culturally interdependent countries. Contagious disease outbreaks persuade a negative impact on an investor's sentiments, which results in wrong investment decisions and affects the prices of the stocks (Liu et al., 2020). ...
Article
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This study examines the impact of the COVID-19 outbreak on the stock markets of G-20 countries. We use an event study methodology to measure abnormal returns (ARs) and panel data regression to explain the causes of ARs. Our sample consists of indices in G-20 countries. The observed window comprises 58 days post the COVID-19 outbreak news release in the international media, and the estimation window consists of 150 days before the event date. We find statistically significant negative ARs in the four sub-event windows during the 58 days. Negative ARs are significant for developing as well as developed countries. The findings of this study reveal that cumulative average abnormal return (CAAR) from day 0 to day 43, ranging from-0.70 per cent to-42.69 per cent, is a consequence of increased panic in the stock markets resulting from an increased number of COVID-19 positive cases in the G-20 countries. From day 43 to day 57, CAAR ranging from-42.69 per cent to-29.77 per cent indicates the recovery of stock markets after a major stock price correction due to COVID-19. Additionally, the results of panel data analysis confirm the recovery of stock markets from the negative impact of COVID-19.
... Nevertheless, AQ: 5 Liu et al. (2020) argued that COVID-19 increased the pessimistic sentiments and investor's fear leading to the market crash. Particularly during the crisis period, the influence of investor sentiments on stock markets is more pronounced (Zouaoui et al., 2011). In contrast to Liu et al. (2020), 1 we considered firmspecific high-frequency investor sentiments as indicators to ensure whether the relationship between COVID-19 cases and stock returns is mediated by investor sentiments. ...
Article
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This article develops a dynamic panel model to examine the association among coronavirus outbreak, investor attention, social isolation, investor sentiments and stock returns in the German Stock exchange. The results of the two-step GMM estimator show a significant effect of coronavirus disease 2019 (COVID-19) cases on the Frankfurt Stock Exchange after controlling for calendar anomalies, meteorological conditions, country-specific factors and oil returns. Results also show that a higher level of stock returns during social isolation (lockdown period) is explained by investor attention to buy underpriced stocks. Thus, temporary social isolation enhances an investor’s ability to make better investment decisions. Investor sentiment indicators (momentum and liquidity) are also positively associated with the stock return and partially mediate the COVID-returns link, but they have no direct effect on investor attention. The stock market attracts investor attention under good news shocks (recovered cases) when investor sentiments are optimistic. Our results are robust across the transparency level of firms and their size.
... These macroeconomic shocks causes economic slowdown and changes the attitudes of investors in the market. The countries which have a culture of following the group consensus and have limited institutional participation, the investor attitude has more effect on the stock market [63,64]. ...
Technical Report
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The report is about the impact of COVID-19 pandemic on different sectors of the economy.
... A large body of empirical literature has considered the effect of investor sentiment on asset returns and price volatility. A stream of the finance literature focuses on the role of investor sentiment in the equity markets, resulting in one of the most challenging results for the classical asset-pricing theories: that sentiment does affect the price of equities Wurgler (2006, 2007); Bandopadhyaya and Jones (2006); Bathia and Bredin (2013) Zouaoui et al. (2011). The results of these studies were considered biased because most of them rely on surveys of investor intelligence or sentiment and/or consumer confidence to measure the sentiment of individual investors because of the unavailability of time series of sentiment indicators. ...
Article
We investigate the effect of investor sentiment on returns and volatility of eight different commodities. Our findings suggest that sentiment has a predictive power on return and volatility of the commodities. Fundamentally, commodities’ return and volatility are positively associated with the sentiment, suggesting that investors in the commodity markets are irrational – the existence of noise trading. Our results confirm the prediction of the affect infusion model in which optimistic investors are willing to take more risk, rising commodity returns and volatility. Furthermore, the empirical evidence suggests that the sentiment has a significant asymmetrical impact on volatilities such that negative sentiment has a significantly greater impact on volatility than positive sentiment does.
... Data are collected from a survey of about 2,800 investors and analysts. Consumer confidence measures have served widely as proxies for investor sentiment (Jansen and Nahuis 2003;Fisher and Statman 2003;Lemmon and Portniaguina 2006;Chui, Titman, and Wei 2010;Zouaoui, Nouyrigat, and Beer 2011). ...
Article
This article investigates the suitability of 13 investor sentiment proxies as causal explanations for monthly stock returns of the European S&P 350 constituents over 45 years. We analyzed a sample of 362 companies covering 16 European countries. Analyses incorporate multiple categories of investor sentiment arising from market or survey data, as well as technical analysis, risk measures, company fundamentals and macroeconomic variables. In addition, we provide an extended review of sentiment proxy measures based on market data. This work applied general model of moments (GMM) to dynamic panel data to estimate short-run and long-run influences along with Granger causality. Our findings demonstrate the role of several investor sentiment measures in predicting stock returns even after controlling for variables such as fundamentals, macroeconomic, market and technical analysis. Together, sentiment measures of implied volatility in stock options, such as VIX and VSTOXX, put and call ratios, gold, government bond yield spreads, mispricing along with economic and confidence sentiment indicators can significantly predict how irrational behaviors of investors can determine stock returns. Co-movements between markets provide further evidence of contagion. Considering the unobservable nature of sentiment, we provide a set of sentiment proxies, and reveal new measures such as gold, government yields spread and a mispricing ratio, that serve to predict European market returns. Furthermore, to our knowledge this study is one of the few studies to apply time dynamic panel data estimation to a large set of sentiment proxies and a set of complete control variables in a long-term framework.
... Although their Granger causality result shows that consumer confidence indices do not Granger-cause GDP and vice versa, the forecast variance decomposition, however, reveals a significant prediction of GDP by the variables adopted. In addition, Zouaoui et al. (2011) investigated the power of consumer confidence indicators to predict financial crises using a panel of 16 international stock markets. Their study outlines two major findings: first, investor sentiment has more impact on stock market returns in countries that have a low market integrity and institutional involvement. ...
Article
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This paper examines the relationship between sentiment-apt investors and UK stock returns at industry level over the period January 1988 to December 2017. Using two new sentiment proxies (laggards to leaders and growth opportunity index) for ten discrete sector groupings, we provide novel evidence on how returns in the UK stock market react to the activities of sentiment-disposed investors. First, using threshold nonlinear regression, we document a significant relationship between the laggards to leaders sentiment proxy and sectoral returns. Our findings reveal that aggregate returns in the sector are affected by activities of investors who embark on profit-taking when there is an increase in the proportion of lagging to leading stocks beyond the threshold value. Secondly, when using the growth opportunity sentiment proxy, we report that the increase in growth above the growth threshold value has a significant impact on sector returns. This study further confirms significant impact of non-threshold variables on sector groupings. Our findings are robust, having been subjected to a range of robustness checks.
... Khan and Park (Khan and Park 2009) discovered contagion in Asia-Pacific stock markets during 12 major crises, of which the Asian crisis is the most influential. Because investors paid more attention to global trends in emerging markets at times of elevated market tensions (Duca 2012), and investor sentiment had a more obvious influence on the stock market in countries more vulnerable to herd behaviour and overreactions, and with lower institutional participation (Zouaoui, Nouyrigat, and Beer 2011). Jong-Wha and Warwick (Jong-Wha and Warwick 2004) evaluated the impact of SARS on the global economy and found that under financial integration and globalization, the rapid spread in SARS through global travel had economic impacts on other countries. ...
Article
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China’s economy and the Asian stock markets have been severely impacted by the COVID-19 outbreak. This article used an event study method to calculate the abnormal returns (AR) in the 10 trading days following the outbreak, from which it was found that both the Chinese and Asian stock markets had significantly declined, with the cumulative abnormal returns (CAR) remaining negative in all the examined event window periods. This article also analysed the different industry index responses to the epidemic, from which it was found that the pharmaceutical manufacturing, software and IT services both had positive CAR, while transportation, lodging and catering had negative CAR during the event window. These results reflected the investors’ expectations for the different industries and the economy as a whole under the outbreak of the contagious coronavirus.
... The macroeconomic variables used in our study similarly to other authors are: the industrial production index (Brown & Cliff, 2004;Baker & Wurgler, 2007;Schmeling, 2009;Fernandes, et al. 2013;Corredor, 2015;Aydogan, 2016;Khan, 2018), short-term interest rates (Fama & Schwert, 1977;Schmeling, 2009;Baker, Wurgel &Yuan, 2012;Fernandes, et al. 2013;Kumari & Mahakud 2015;Aydogan, 2016) monthly variation in the consumer price index (Zouaoui, 2011;Fernandes, et al. 2013;Sayim, Morris & Rahmam 2013, Aydogan, 2016. ...
Article
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This study assesses the impact of investor sentiment on the volatility of the PSI 20 and IBEX 35 from time series data from January 1988 to May 2019. The impact of investor sentiment on market and portfolio selection has aroused great interest in the literature, however the results obtained are not consensual, considering the different methodologies used to build sentiment indices, as well as the various levels of institutional development in the market. Asymmetric volatility behaviours according to good or bad news were evaluated using the TGARCH model. The results indicate that there is an asymmetric effect of good versus bad news on the volatility of IBEX 35. It was also noted that for Portugal and Spain investor sentiment presents statistical significance with a negative sign, suggesting that market volatility is more sensitive to negative shocks in the conditional variance. In Portugal, contrary to Spain, sentiment has no relevance on return. The study reveals that investor sentiment is a key factor in selecting investment in the market. The relationship that this establishes with volatility, can help to implement policies that allow to minimize future shocks’ impact on return. The study reveals for the first time that investor sentiment is a key factor in selecting investment in the market for Portugal.
... Events like infectious disease outbreaks can induce negative changes in investors' sentiment that strongly affects their investment decisions and, consequently, stock market prices. In countries that are culturally more susceptible to herd-like actions and overreaction or countries with low institutional participation, the effect of investor sentiment on stock markets is more pronounced [29,30]. ...
Article
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This paper evaluates the short-term impact of the coronavirus outbreak on 21 leading stock market indices in major affected countries including Japan, Korea, Singapore, the USA, Germany, Italy, and the UK etc. The consequences of infectious disease are considerable and have been directly affecting stock markets worldwide. Using an event study method, our results indicate that the stock markets in major affected countries and areas fell quickly after the virus outbreak. Countries in Asia experienced more negative abnormal returns as compared to other countries. Further panel fixed effect regressions also support the adverse effect of COVID-19 confirmed cases on stock indices abnormal returns through an effective channel by adding up investors’ pessimistic sentiment on future returns and fears of uncertainties.
... Nevertheless, AQ: 5 Liu et al. (2020) argued that COVID-19 increased the pessimistic sentiments and investor's fear leading to the market crash. Particularly during the crisis period, the influence of investor sentiments on stock markets is more pronounced (Zouaoui et al., 2011). In contrast to Liu et al. (2020), 1 we considered firmspecific high-frequency investor sentiments as indicators to ensure whether the relationship between COVID-19 cases and stock returns is mediated by investor sentiments. ...
... On the other hand, firm performance is also measured by market performance of firms' shares proxied by Tobin's Q (Fu et al., 2016). However, firms' market performance may be subjective to investor sentiment and/or other irrational behaviours (Zouaoui et al., 2011). Therefore, to examine firms' performance, accounting based measures are preferred since they reflect firms' intrinsic performance without influences of external factors. ...
Article
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Motivated from the shortage of the existing research studies on impacts of dangerously contagious diseases on firms’ financial performance, this study sheds light on the impacts of Coronavirus (Covid-19) outbreak on financial performance upon on the quarterly data of 126 Chinese listed firms across 16 industries. Overall, the Covid-19 outbreak reduced Chinese listed firms’ financial performance proxied by the revenue growth rate, ROA, ROE, and asset turnover. This outbreak’s negative effects on Chinese firms’ profitability were much smaller than that on their revenue growth rates. While this outbreak’s negative effects on financial performance of Chinese listed firms were bigger for those that were seriously affected by this pandemic like airlines, travel, and entertainment (ATE), this pandemic’s effects were positive for the medicine industry. In the meanwhile, Chinese listed firms that located in high-risk regions suffered a bigger financial loss during the outbreak, and especially there was a strong Hubei effect. The corporate culture and CSR moderated the inverse relationship between this outbreak and Chinese firms’ financial performance. Findings of this study contribute to enrich the existing literature on impacts of the Covid-19 outbreak on firms’ financial performance worldwide and suggest helpful practical and theoretical implications.
... Investor's sentiment has been considered as an important aspect to analyze the economic and financial phenomena [18]- [20]. To investigate the investment sentiment of users on r/WSB, it is necessary to use an appropriate social media-orientated SP dictionary rather than a general sentiment dictionary. ...
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In January 2021, the users of subreddit r/wallstreetbets (WSB) triggered an unprecedented short squeeze by driving up GameStop's stock price to an unimaginable high point. During the event, a large number of users participated in the discussion about GameStop and coordinated trading behavior on r/WSB to push the stock price higher. In this article, we investigate the characteristics of the collective behaviors and social dynamics from the evolutions of topological structure, discussed topics, and user sentiment polarity (SP) by constructing dynamic interaction networks, modeling the topic, and analyzing the user sentiment. We find that the topological structure of the interaction network evolves toward a more efficient direction, the discussed topics change more centralized, and the user sentiment tends to be more positive and divergent. And we reveal that part of GameStop's stock price is explained by the social media activity, popularity of the dominant topic, topic cohesiveness, SP of users, and sentiment divergence between interacted users on r/WSB. Our work quantitatively characterizes the interaction networks and user behavior during the GameStop short squeeze and provides an example to analyze the event which synchronously evolves in the physical space and cyberspace. It not only contributes to the analysis of social system behavior and structure but also provides valuable insights into the financial practice and policy decision-making.
... On the other hand, firm performance measures by the market performance of firms' shares proxied by Tobin's Q (18). However, firms' market performance may be subjective to investor sentiment and other irrational behaviors (19). Therefore, to examine firms' performance of firms, accounting based measures are preferred since they reflect firms' intrinsic performance without influences of external factors. ...
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This research described Chinese listed firms' COVID-19 Outbreak and financial performance using corporate culture (CC) and corporate social responsibility (CSR) evidence. The epidemic's impact on Chinese companies' profits was much less than the impact on their sales growth rates. Although the COVID-19 has had a more significant negative impact on the financial performance of Chinese listed companies in sectors that are more severely impacted, such as travel and entertainment, we believe that the financial performance of the medical industry has improved as a result of the outbreak. Meanwhile, Chinese listed companies in high-risk areas experience more significant financial losses during the epidemic, and the Hubei impact is hefty weight. Corporate social responsibility moderated the inverse relationship between this epidemic and Chinese firms' economic success. This research enhances the current literature on the effects of the COVID-19 on financial success and practical, realistic, and theoretical consequences in companies worldwide.
... Firstly, some differences were found in the size of the observed stock markets, market development, and concentration, as explained in [37], and due to greater connectedness of certain stock markets with the West European ones [99]. Other differences can be found in [8,100]: Investor sentiment is different in countries that are different in terms of cultural independence or interdependence. Analyzed countries differ one from another in these terms. ...
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This research deals with stock market reactions of Central Eastern and South Eastern European (CESEE) markets to the COVID-19 pandemic, via the event study methodology approach. Since the stock markets react quickly to certain announcements, the used methodology is appropriate to evaluate how the aforementioned markets reacted to certain events. The purpose of this research was to evaluate possibilities of obtaining profits on the stock markets during great turbulences, when a majority of the participants panic. More specifically, the contrarian trading strategies are observed if they can obtain gains, although a majority of the markets suffer great losses during pandemic shocks. The contributions to the existing literature of this research are as follows. Firstly, empirical research on CESEE stock markets regarding other relevant topics is still scarce and should be explored more. Secondly, the event study approach of COVID-19 effects utilized in this study has (to the knowledge of the author) not yet been explored on the aforementioned markets. Thirdly, based on the results of CESEE market reactions to specific announcements regarding COVID-19, a simulation of simple trading strategies will be made in order to estimate whether some investors could have profited in certain periods. The results of the study indicate promising results in terms of exploiting other investors’ panicking during the greatest decline of stock market indices. Namely, the initial results, as expected, indicate strong negative effects of specific COVID-19 announcements on the selected stock markets. Secondly, the obtained information was shown to be useful for contrarian strategy in order to exploit great dips in the stock market indices values. View Full-Text
... recessions and mental health outcomes and find that the economic recession impacts many aspects of mental health such as substance disorder and ultimately the suicidal behaviour. On the other hand, scholars have shown that the behaviour of investors changes significantly during economic and financial crisis periods (See e.g. Hoffmann et. al., 2013;Zouaoui et. al., 2011). ...
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... They demonstrate that sentiment affects the stock prices during this crash, but not in the surrounding period. For the period between April 1995 and June 2009, Zouaoui et al. (2011) show investor sentiment proxied by consumer confidence index has a significant effect on financial markets during crisis periods, especially for countries subject to more herd-like behavior and low institutional development. A similar relationship is observed between sentiment and Turkish stock markets for the crisis periods. ...
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... Bayram (2017) uses rational and irrational consumer and business sentiment, and reports that both influence the returns of the stocks listed on the ISE. Zouaoui et al. (2010) use panel data of 15 European and the US stock markets and find that sentiment has more effect on stock returns in those countries where investors are prone to herd behaviour and institutional investment is relatively low. Grigaliuniene and Cibulskiene (2010) examine the effect of sentiment in Scandinavian markets and report an inverse relationship between sentiment and future stock returns. ...
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Google search data has received considerable attention for its predictive ability in various social and economic outcomes. In the arena of investments, a surge in online searches indicates an enhanced interest of investors, particularly retail, in that company. In this article, we have examined the association between Google search and stock prices in a sample of Indian companies. The results suggest that an increase in Google search is positively related to future excess stock returns, liquidity and volatility. The positive influence of Google search on stock prices, however, is temporary and reverses in the next week. We further show that the market sentiment moderates the interconnection between Google searches and future excess stock returns. The findings are in consonance with the 'price pressure hypothesis' of Barber and Odean (2008, Review of Financial Studies, 21(2), 785-818).
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Behavioral finance is a new approach in financial markets that has emerged as a result of the complications long-faced by the traditional finance theory. This research investigates the impact of investor sentiment and herding behavior on stock market liquidity using an empirical study on the Egyptian Stock Market. The research addresses one of the up-to-date topics in finance that cannot be considered consumed or obsolete. It examines the direct impact of the Egyptian investor sentiment on the Egyptian Stock Market liquidity. It also examines the indirect impact of the Egyptian investor sentiment on the Egyptian Stock Market liquidity through the investor’s herding behavior Therefore, this research adds to the body of knowledge by investigating these effects in an emerging market-the Egyptian market. Its major contribution is filling the gap of indirect sentiment-liquidity impact conflict. Monthly data of the EGX30 index from January 2004 up to December 2018 were used in building up investor sentiment index, investor herding behavior, and stock market liquidity measures. Moreover, there are two additional types of data that represent key measures that are used to build up investor sentiment index for the same period of this research. These two measures are: the closed-end mutual fund discounts and the equity open-end mutual fund flows. Additionally, the researcher uses four control variables for stock market liquidity, namely market volatility, excess market return, term spread, and lag of the dependent variable, considering that the fourth variable is also used for investor herding behavior. The researcher uses the deductive approach taking into consideration two types of statistical techniques, namely Structural Equation Modeling (SEM) and event study. The event study employed in this study utilizes four major events which are: the September 2008 Global Financial Crisis, 25 January 2011 Revolution, 30 June 2013 Revolution, and November 2016 Egyptian Pound Floatation. The main findings of this research indicated that the investor sentiment index has both; a positive direct impact on stock market liquidity and a negative indirect one through the mediator variable-investor herding behavior. In addition, the findings of the event study show that there are different signs of the direct and indirect impacts and different levels of correlation between the research variables throughout the four different events which differ completely from the usual signs and correlations of the theoretical background. Keywords: Behavioral Finance; Investor Sentiment; Investor Herding Behavior; Stock Market Liquidity; Egypt; Structural Equation Modeling (SEM); Event Study; EGX30
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We assess the impact of investor sentiment on future stock returns in 50 global stock markets. Using the consumer confidence index (CCI) as the sentiment proxy, we document a negative relationship between investor sentiment and future stock returns at the global level. While the separation between developed and emerging markets does not disrupt the negative pattern, investor sentiment has a more instant impact in emerging markets, but a more enduring impact in developed markets. Individual stock markets reveal heterogeneity in the sentiment-return relationship. This heterogeneity can be explained by cross-market differences in culture and institutions, along with intelligence and education, to varying degrees influenced by the extent of individual investor market participation.
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A significant body of empirical research has shown that investor sentiment is an essential factor to explain stock price that the classical financial theory cannot explain. This research examines the relationship between stock return and investor sentiment using the Vietnamese stock exchange data. We create a sentiment index using the principal components analysis (PCA). Consistent with the sentiment and stock return literature, the research shows a negative contemporaneous relationship between investor sentiment and market return.
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Investors are not all alike, and neither are their sentiments. We show that the sentiment of Wall Street strategists is unrelated to the sentiment of individual investors or that of newsletter writers, although the sentiment of the last two groups is closely related. Sentiment can be useful for tactical asset allocation. We found a negative relationship between the sentiment of each of these three groups and future stock returns, and the relationship is statistically significant for Wall Street strategists and individual investors.
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The sentiment of newsletter writers, whether bullish or bearish, does not forecast future returns, but past returns and the volatility of those returns do affect sentiment. High returns over four-week periods are associated with a migration of newsletter writers from the bearish camp into the bullish camp. High returns over periods of 26 and 52 weeks are associated with "nervous bullishness" - a migration of newsletter writers from the bearish camp into both the bullish and the correction camps. High volatility, instead of scaring newsletter writers into bearishness, reduces the effects of both positive and negative returns on sentiment. Also, contrary to a popular hypothesis, the crash of 1987 had no significant effect on the pattern of forecasts.
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The use of price-earnings ratios and dividend-price ratios as forecasting variables for the stock market is examined using aggregate annual US data 1871 to 2000 and aggregate quarterly data for twelve countries since 1970. Various simple efficient-markets models of financial markets imply that these ratios should be useful in forecasting future divi- dend growth, future earnings growth, or future productivity growth. We conclude that, overall, the ratios do poorly in forecasting any of these. Rather, the ratios appear to be useful primarily in forecasting future stock price changes, contrary to the simple efficient-markets models. This paper is an update of our earlier paper (1998), to take account of the remarkable behavior of the stock market in the closing years of the twentieth century.
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Whether investor sentiment has any bearing on asset returns has long been a topic of interest in finance. In this paper I examine whether sentiment, as measured by yearly change in the University of Michigan Consumer Sentiment Index, affects stock returns. I find that changes in consumer sentiment reliably predict excess stock market returns at one-month and one-year horizons over 1979-2000 and 1955-2000 periods. Its univariate prediction is stronger than other popular stock return predictors. Change in consumer sentiment performs better than an ARI benchmark model in out-of-sample forecasting tests. Changes in consumer sentiment predict future excess stock returns after controlling for dividend yield, the book-to-market ratio of the Dow Jones Industrial Average, the slope of the term structure, the yield spread between Baa and Aaa bonds, the short rate yield, lagged excess market returns, and the consumption-wealth ratio. The predictability of change in consumer sentiment is mostly unrelated to economic cycles as measured by real GDP growth or consumption growth.
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This paper examines legal rules covering protection of corporate shareholders and creditors, the origin of these rules, and the quality of their enforcement in 49 countries. The results show that common law countries generally have the best, and French civil law countries the worst, legal protections of investors, with German and Scandinavian civil law countries located in the middle. We also find that concentration of ownership of shares in the largest public companies is negatively related to investor protections, consistent with the hypothesis that small, diversified shareholders are unlikely to be important in countries that fail to protect their rights.
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This paper examines the importance of diff erent economic sentiments, e.g. consumer moods, for the Central and Eastern European countries (CEECs) during the transition process. We fi rst analyze the importance of economic confi dence with respect to the CEECs’ fi nancial markets. Since the integration of formerly strongly-regulated markets into global markets can also lead to an increase in the dependence of the CEECs’ domestic market performance on global sentiments, we also investigate the relationship between global economic sentiments and domestic income and share prices. Finally, we test whether the impact of global sentiments and stock prices on domestic variables increases proportionally with the degree of integration. We also account for eff ects stemming from global income. For these purposes, we apply a restricted cointegrating VAR (CVAR) framework based upon a restricted autoregressive model which allows us to distinguish between the long-run and the short-run dynamics. For the long run we fi nd evidence supporting relationships between sentiments, income and share prices in the case of the Czech Republic. Our results for the short run suggest that economic sentiments in general are infl uenced by share prices but also off er some predictive power with respect to the latter. What is more, European sentiments play an important role in particular for the CEECs’ share prices and income. The signifi cance of this link increases with economic integration.
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This paper evaluates three models for predicting currency crises that were proposed before 1997. The idea is to answer the question: if we had been using these models in late 1996, how well armed would we have been to predict the Asian crisis? The results are mixed. Two of the models fail to provide useful forecasts. One model provides forecasts that are somewhat informative though still not reliable. Plausible modifications to this model improve its performance, providing some hope that future models may do better. This exercise suggests, though, that while forecasting models may help indicate vulnerability to crisis, the predictive power of even the best of them may be limited. Copyright 1999, International Monetary Fund
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This article explores how a multivariate logit model of the probability of a banking crisis can be used to monitor banking sector fragility. The proposed approach relies on readily available data, and the fragility assessment has a clear interpretation based on in-sample statistics. The model has better in-sample performance than currently available alternatives, and the monitoring system can be tailored to fit the preferences of decisionmakers regarding type I and type II errors. The framework can be useful as a preliminary screen to economize on precautionary costs. Copyright 2000 by Oxford University Press.
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This paper examines fifteen historical episodes of stock market crashes and their aftermath in the United States over the last one hundred years. Our basic conclusion from studying these episodes is that financial instability is the key problem facing monetary policy makers and not stock market crashes, even if they reflect the possible bursting of a bubble. With a focus on financial stability rather than the stock market, the response of central banks to stock market fluctuations is more likely to be optimal and maintain support for the independence of the central bank.
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Financial advisors who worked to restrain exuberant investors in the late 1990s, worked equally hard to lift desperate investors in the early 2000s. Will lower stock prices sap the confidence of consumers? Will lower consumer confidence extinguish all hope for investors? We study the consumer confidence measures of the Conference Board and the University of Michigan and the investor sentiment measures of the American Association of Individual Investors and Investor's Intelligence. We find that consumers grow confident when investors grow bullish. Consumer confidence declines when stock prices decline but investors need not fear that declines in consumer confidence would be followed by low stocks returns. Low consumer confidence is followed by high stock returns more often than it is followed by low stock returns.
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This paper tests the widely held proposition that investor sentiment contributed to the stock market crash of 1987. Using weekly data during the 1986–8 period and conventional measures of stock fundamentals, changes in fundamentals are found to have a statistically significant influence on the movement of stock prices. In addition, a much-discussed measure of investor sentiment is used to test the proposition that investor sentiment contributed to the stock market crash of 1987. However, insignificant results regarding the investor sentiment index suggest that either the recently proposed sentiment index is faulty or investor sentiment did not significantly influence stock prices in the period surrounding the 1987 crash.
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The Second Edition of this classic work, first published in 1981 and an international bestseller, explores the differences in thinking and social action that exist among members of more than 50 modern nations. Geert Hofstede argues that people carry "mental programs" which are developed in the family in early childhood and reinforced in schools and organizations, and that these programs contain components of national culture. They are expressed most clearly in the different values that predominate among people from different countries. Geert Hofstede has completely rewritten, revised and updated Cultures Consequences for the twenty-first century, he has broadened the book's cross-disciplinary appeal, expanded the coverage of countries examined from 40 to more than 50, reformulated his arguments and a large amount of new literature has been included. The book is structured around five major dimensions: power distance; uncertainty avoidance; individualism versus collectivism; masculinity versus femininity; and long term versus short-term orientation. --Publisher.
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The link between asset valuations and investor sentiment is the subject of con-siderable debate in the profession. We address this question by examining how survey data on investor sentiment relates to i) long-horizon returns, and ii) asset valuations. If excessive optimism drives prices above intrinsic values, periods of high sentiment should be followed by low returns as market prices revert to fundamental values. We find this to be the case for the overall stock market at horizons of two to three years. The relation is strongest for large-capitalization, low book-to-market (growth) portfolios. We also examine the relation between sentiment levels and deviations from intrinsic value. Using errors from an inde-pendent pricing model, we find sentiment is positively related to valuation errors using a variety of tests. All of our results are robust to the inclusion of other factors that have been shown to forecast stock returns, including past returns., seminar participants at the Federal Reserve Board, the University of North Car-olina, Virginia Tech, the 1999 Western Finance Association meeting (especially the discussant, Bhaskaran Swaminathan), the 1999 Financial Management Association meeting, and the 2000 Batten Young Scholars Conference at William & Mary for their comments and suggestions. We also thank Gurdip Bakshi, Zhiwu Chen, Ken French, and Steve Sharpe for providing data.
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This paper investigates a relation between investor sentiment and performance of value stocks over growth stocks. To measure noise investors' sentiment, we use gauges: the CBOE equity put-call ratio and the market volatility (VIX) index. We find that value stocks tend to outperform growth stocks when the CBOE equity put-call ratio is relatively low or the VIX is relatively high. When the put-call ratio is relatively high or the VIX is relatively low, however, growth stocks marginally outperform or perform as well as value stocks. This finding suggests that the return premium of value stocks over growth stocks is at least partially influenced by investor sentiment. A strategy that switches equity styles on the basis of the put-call ratio seems to beat the benchmarks.
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Public equity offerings by seasoned firms (SEOs) exhibit similar but less volatile cycles than initial public offerings (IPOs) of newly public firms. Our paper provides a comprehensive examination of the factors that cause variation in the number of firms issuing SEOs. Specifically, we use four factors from studies of IPOs as potential determinants of SEO cycles. We find that whether tested separately or collectively, only the demand for capital and market timing hypotheses receive strong empirical support in explaining SEO volume. Investor sentiment is not an important factor in explaining SEO volume, nor is information asymmetry.
Book
The efficient markets hypothesis has been the central proposition in finance for nearly thirty years. It states that securities prices in financial markets must equal fundamental values, either because all investors are rational or because arbitrage eliminates pricing anomalies. This book describes an alternative approach to the study of financial markets: behavioral finance. This approach starts with an observation that the assumptions of investor rationality and perfect arbitrage are overwhelmingly contradicted by both psychological and institutional evidence. In actual financial markets, less than fully rational investors trade against arbitrageurs whose resources are limited by risk aversion, short horizons, and agency problems. The book presents and empirically evaluates models of such inefficient markets. Behavioral finance models both explain the available financial data better than does the efficient markets hypothesis and generate new empirical predictions. These models can account for such anomalies as the superior performance of value stocks, the closed end fund puzzle, the high returns on stocks included in market indices, the persistence of stock price bubbles, and even the collapse of several well-known hedge funds in 1998. By summarizing and expanding the research in behavioral finance, the book builds a new theoretical and empirical foundation for the economic analysis of real-world markets.
Article
This paper assesses whether incorporating investor sentiment as conditioning information in asset-pricing models helps capture the impacts of the size, value, liquidity and momentum effects on risk-adjusted returns of individual stocks. We use survey sentiment measures and a composite index as proxies for investor sentiment. In our conditional framework, the size effect becomes less important in the conditional CAPM and is no longer significant in all the other models examined. Furthermore, the conditional models often capture the value, liquidity and momentum effects.
Article
We investigate investor sentiment and its relation to near-term stock market returns. We find that many commonly cited indirect measures of sentiment are related to direct measures (surveys) of investor sentiment. However, past market returns are also an important determinant of sentiment. Although sentiment levels and changes are strongly correlated with contemporaneous market returns, our tests show that sentiment has little predictive power for near-term future stock returns. Finally, our evidence does not support the conventional wisdom that sentiment primarily affects individual investors and small stocks.
Article
We examine whether consumer confidence – as a proxy for individual investor sentiment – affects expected stock returns internationally in 18 industrialized countries. In line with recent evidence for the U.S., we find that sentiment negatively forecasts aggregate stock market returns on average across countries. When sentiment is high, future stock returns tend to be lower and vice versa. This relation also holds for returns of value stocks, growth stocks, small stocks, and for different forecasting horizons. Finally, we employ a cross-sectional perspective and provide evidence that the impact of sentiment on stock returns is higher for countries which have less market integrity and which are culturally more prone to herd-like behavior and overreaction.
Article
There are several types of risk aversion indicators used by financial institutions. These indicators, which are estimated in diverse ways, often show differing developments, although it is not possible to directly assess which is the most appropriate. Here, we consider the most well-known of these indicators and construct others with standard methods. As financial crises generally coincide with periods in which risk aversion increases, we try to check if these indicators rise just before the crises and also if they are able to forecast crises. We estimate logit and multilogit models of financial crises – exchange rate and stock market crises – using control variables and each of the risk aversion indicators. In-sample simulations allow us to assess their respective predictive powers. Risk aversion indicators are found to be good leading indicators of stock market crises, but less so for currency crises.
Article
We use a panel of annual data for over 100 developing countries from 1971 through 1992 to characterize currency crashes. We define a currency crash as a large change of the nominal exchange rate that is also a substantial increase in the rate of change of nominal depreciation. We examine the composition of the debt as well as its level, and a variety of other macroeconomic factors, external and foreign. Crashes tend to occur when: output growth is low; the growth of domestic credit is high; and the level of foreign interest rates are high. A low ratio of FDI to debt is consistently associated with a high likelihood of a crash.
Article
This paper develops a new early warning system (EWS) model, based on a multinomial logit model, for predicting financial crises. It is shown that commonly used EWS approaches, which use binomial discrete-dependent-variable models, are subject to what we call a post-crisis bias. This bias arises when no distinction is made between tranquil periods, when economic fundamentals are largely sound and sustainable, and crisis/post-crisis periods, when economic variables go through an adjustment process before reaching a more sustainable level or growth path. We show that applying a multinomial logit model, which allows distinguishing between more than two states, is a valid way of solving this problem and constitutes a substantial improvement in the ability to forecast financial crises. The empirical results reveal that, for a set of 20 open emerging markets for the period 1993–2001, the model would have correctly predicted a large majority of crises in emerging markets.
Article
Economists directly observe warranted values in only a few cases. One is that of closed-end mutual funds: their fundamental value is simply the current market value of the securities that make up their portfolios. We use the difference between prices and net asset values of closed-end mutual funds at the end of the 1920s to estimate the degree to which the stock market was overvalued on the eve of the 1929 crash. We conclude that the stocks making up the S P composite were priced at least 30 percent above fundamentals in late summer, 1929.
Article
We compare price-to-earnings ratios and dividend yields, which are indirect measures of sentiment, with the bullish sentiment index, which is a direct measure. We find that the sentiment index does better as a market-timing tool than do P/E ratios and dividend yields, but none is very reliable. We do not argue that market timing is impossible. Rather, we observe that stock prices reflect both sentiment and value, both of which are difficult to measure and neither of which is perfectly known in foresight. Successful market timing requires insights into future sentiment and value, insights beyond those that are reflected in widely available measures. 2006 The Southern Finance Association and the Southwestern Finance Association.
Article
This paper examines how cultural differences influence the returns of momentum strategies. Cross-country cultural differences are measured with an individualism index developed by Hofstede (2001) , which is related to overconfidence and self-attribution bias. We find that individualism is positively associated with trading volume and volatility, as well as to the magnitude of momentum profits. Momentum profits are also positively related to analyst forecast dispersion, transaction costs, and the familiarity of the market to foreigners, and negatively related to firm size and volatility. However, the addition of these and other variables does not dampen the relation between individualism and momentum profits. Copyright (c) 2009 the American Finance Association.
Article
We construct indexes of investor sentiment for six major stock markets and decompose them into one global and six local indexes. Relative market sentiment is correlated with the relative prices of dual-listed companies, validating the indexes. Both global and local sentiment are contrarian predictors of the time series of major markets' returns. They are also contrarian predictors of the time series of cross-sectional returns within major markets: When sentiment from either global or local sources is high, future returns are low on various categories of difficult to arbitrage and difficult to value stocks. Sentiment appears to be contagious across markets based on tests involving capital flows, and this presumably contributes to the global component of sentiment.
Article
Estudio acerca de los procesos que dan origen a las diferencias de pensamiento y acción social entre las culturas nacionales. El autor sostiene que los seres humanos llevan consigo "programas mentales" que son desarrollados tempranamente en el medio familiar y reforzados en las instituciones educativas y las organizaciones. Para Geert Hofstede, las diferencias culturales tienen su expresión más clara en las escalas de valores de miembros de distintas naciones y se extienden a los comportamientos, instituciones y organizaciones.
Article
With the recent flurry of articles declaiming the death of the rational markets hypothesis, it is well to pause and recall the very sound reasons this hypothesis was once so widely accepted at least in academic circles. Although academic models often assume that all investors are rational, this is clearly an expository device not to be taken seriously. However, what is in contention is whether markets are "rational" in the sense that prices are set as if all investors are rational. Even if markets are not rational in this sense, there may still not be abnormal profits opportunities. In that case, we say the markets are "minimally rational". This article maintains that developed financial markets are minimally rational and, with two qualifications, even achieve the higher standard of rationality. In particular, it contends that realistically, market rationality needs to be defined so as to allow investors to be uncertain about the characteristics of other investors in the market. It also argues that investor irrationality, to the extent it affects prices, is particularly likely to be manifest through overconfidence, which in turn is likely to make the market in an important sense hyper-rational. To illustrate, the paper ends by re-examining some of the most serious evidence against market rationality: excess volatility, the risk premium puzzle, the size anomaly, closed-end fund discounts, calendar effects and the 1987 stock market crash.
Article
The authors present a simple overlapping generations model of an asset market in which irrational noise traders with erroneous stochastic beliefs both affect prices and earn higher expected returns. The unpredictability of noise traders' beliefs creates a risk in the price of the asset that deters rational arbitrageurs from aggressively betting against them. As a result, prices can diverge significantly from fundamental values even in the absence of fundamental risk. Moreover, bearing a disproportionate amount of risk that they themselves create enables noise traders to earn a higher expected return than rational investors do. The model sheds light on a number of financial anomalies. Copyright 1990 by University of Chicago Press.
Article
The link between asset valuation and investor sentiment is the subject of considerable debate in the profession. If excessive optimism drives prices above intrinsic values, periods of high sentiment should be followed by low returns, as market prices revert to fundamental values. Using survey data on investor sentiment, we provide evidence that sentiment affects asset valuation. Market pricing errors implied by an independent valuation model are positively related to sentiment. Future returns over multiyear horizons are negatively related to sentiment. These results are robust to the inclusion of other variables that have been shown to forecast stock returns.
Article
This article provides direct evidence on the empirical importance of tax-reduction strategies. The authors' results indicate that relatively few investors trade securities to reduce their taxes and that tax-induced trading has little effect on stock prices. Their findings suggest that, holding all else constant, stock prices are likely to be insensitive to the difference between short- and long-term capital gains tax rates. Copyright 1994 by University of Chicago Press.
Article
This paper confirms that changes in consensus corporate profit forecasts and interest rates were completely unable to explain the rise and subsequent collapse of stock prices during 1987. The equity risk premium would have had to fall and then rise by about 4 percentage points to explain the behavior of stock prices around the crash on the basis of standard valuation models. Such shifts did not occur during the 1990-91 stock market cycle. There was, however, an unusually wide divergence of future profit forecasts before the crash, a phenomenon that may have left the market vulnerable to shifting investing sentiment. Copyright 1992 by University of Chicago Press.
Article
In this paper, we propose a measure of individual investor sentiment that is derived from the market for bank-issued warrants. Due to a unique warrant transaction data set from a large discount broker we are able to calculate a daily sentiment measure and test whether individual investor sentiment is related to daily stock returns by using vector autoregressive models and Granger causality tests. We find that there exists a mutual influence of sentiment and stock market returns, but only in the very short-run (one and two trading days). Returns have a negative influence on sentiment, while the influence of sentiment on returns is positive for the next trading day. The influence of stock market returns on sentiment is stronger than vice versa. Our sentiment measure simultaneously avoids problems that are associated with existing sentiment measures, which are based on the closed-end fund discount, stock market transactions, the put-call ratio or investor surveys.
Article
The effects of noise on the world, and on our views of the world, are profound. Noise in the sense of a large number of small events is often a causal factor much more powerful than a small number of large events can be. Noise makes trading in financial markets possible, and thus allows us to observe prices for financial assets. Noise causes markets to be somewhat inefficient, but often prevents us from taking advantage of inefficiencies. Noise in the form of uncertainty about future tastes and technology by sector causes business cycles, and makes them highly resistant to improvement through government intervention. Noise in the form of expectations that need not follow rational rules causes inflation to be what it is, at least in the absence of a gold standard or fixed exchange rates. Noise in the form of uncertainty about what relative prices would be with other exchange rates make us think incorrectly that changes in exchange rates or inflation rates cause changes in trade or investment flows or economic activity. Most generally, noise makes it very difficult to test either practical or academic theories about the way that financial or economic markets work. We are forced to act largely in the dark.
Article
We explore the time-series relationship between investor sentiment and the small-stock premium using consumer confidence as a measure of investor optimism. We estimate the components of consumer confidence related to economic fundamentals and investor sentiment. After controlling for the time variation of beta, we study the time-series variation of the pricing error with sentiment. Over the last 25 years, investor sentiment measured using consumer confidence forecasts the returns of small stocks and stocks with low institutional ownership in a manner consistent with the predictions of models based on noise-trader sentiment. Sentiment does not appear to forecast time-series variation in the value and momentum premiums. (JEL G10, G12, G14)
Article
We examine the predictive power of the dividend yields for forecasting excess returns, cash flows, and interest rates. Dividend yields predict excess returns only at short horizons together with the short rate and do not have any long-horizon predictive power. At short horizons, the short rate strongly negatively predicts returns. These results are robust in international data and are not due to lack of power. A present value model that matches the data shows that discount rate and short rate movements play a large role in explaining the variation in dividend yields. Finally, we find that earnings yields significantly predict future cash flows. (JEL C12, C51, C52, E49, F30, G12)
Article
Closed-end mutual funds provide one of the few cases in which economists can observe "fundamental" values directly, and compare them to market values: the fundamental value of a closed-end fund is simply the net asset value of its portfolio. We use the difference between prices and asset values of closed-end funds at the end of the 1920s as a measure of investment sentiment. In the late l920s closed-end funds sold at large premia: at the peak, they appear willing to pay 60 percent more for closed-end funds than the post-WWII norm. Such substantial overpricing of closed-end funds -- where fundamentals are known and observed -- suggests that other assets were selling at prices above fundamentals as well. The association between movements in the medium closed-end fund discount and movements in broad stock price indices leads us to conclude that the stocks making up the S & P composite were priced at least 30 percent above fundamentals in the summer of 1929.
Article
Questionnaires were sent out at the time of the October 19, 1987 stock market crash to both individual and institutional investors inquiring about their behavior during the crash. Nearly 1000 responses were received. The survey results show that: 1. no news story or rumor appearing on the 19th or over the preceding weekend was responsible for investor behavior, 2. investors' importance rating of news appearing over the preceding week showed only a slight relation to decisions to buy or sell, 3. there was a great deal of investor talk and anxiety around October 19, much more than suggested by the volume of trade, 4. Many investors thought that they could predict the market, 5. Both buyers and sellers generally thought before the crash that the market was overvalued, 6. Most investors interpreted the crash as due to the psychology of other investors, 7. Many investors were influenced by technical analysis considerations, 8. Portfolio insurance is only a small part of predetermined stop-loss behavior, and 9. Some investors changed their investment strategy before the crash.