The relationship between market sentiment index and stock rates of return: a panel data analysis

Abstract

This article analyzes the relationship between market sentiment and future stock rates of return. We used a methodology based on principal component analysis to create a sentiment index for the Brazilian market with data from 1999 to 2008. The sample consisted of companies listed on BM&FBOVESPA which were grouped into quintiles, each representing a portfolio, according to the magnitude of the following characteristics: market value, total annualized risk and listing time on BM&FBOVESPA. Next, we calculated the average return of each portfolio for every quarter. The data for the first and last quintiles were analyzed via two-factor ANOVA, using sentiment index of the previous period (positive or negative) as the main factor and each characteristic as controlling factors. Finally, the sentiment index was included in a panel data pricing model. The results indicate a significant and negative relationship between the market sentiment index and the future rates of return. These findings suggest the existence of a reversion pattern in stock returns, meaning that after a positive sentiment period, the impact on subsequent stock returns is negative, and vice-versa.

Anomalies and Investor Sentiment: Empirical Evidences in the Brazilian Market

“…The averages of the NIPO, NEI and TURN variables are lower than those used by Yoshinaga and Castro (2012), whose values were 4.02, 0.32 and 0.18, respectively. Note that a lower average is expected in the case of the NIPO variable, since this work is considering a monthly frequency.…”

“…Martins, Pereira, Amorim, Oliveira and Oliveira (2010) studied the relation between investor sentiment and firm book-to-market ratios and did not find a significant relation. Yoshinaga and Castro (2012) found a negative and significant relation between the sentiment index and future returns in the Brazilian market. Such evidence -that the investor sentiment index is an important component of asset pricing in Brazil -make way for new questions related to the intensity and way investor sentiment influences returns.…”

“…In this phase, we used a set of proxies that were already used in previous works, such as Brown and Cliff (2004), Wurgler (2006, 2007), and Yoshinaga and Castro (2012), applied to the US and Brazilian market, respectively. The proxies selected to make up the index are: number of initial public offers ( ), percentage of new equity issues ( ), stock turnover ( ) and advancing issues to declining issues ratio ( ).…”

“…This ratio is found in the average values provided by Baker, Wurgler and Yuan (2012), who used indices with variance explanation of 38%, 40%, 49%, 37%, 37% and 42%, for Canada, France, Germany, Japan, the UK and the USA, respectively. Yoshinaga and Castro (2012) used an index where 49% of the variance was explained by the first component. Such difference may be due to a difference in the proxies used or to the influence of the common idiosyncratic variation in higher frequencies.…”

“…Among the most cited works on sentiment index is that of Baker and Wurgler (2006), who developed a sentiment index constructed on the first principal component of six proxies related to investor behavior. In the Brazilian market, Yoshinaga and Castro (2012) have found evidence that the investor sentiment index is an important component in asset pricing.…”