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

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.

The Roles of Investor Sentiment in Malaysian Stock Market

“…In addition, since affect is a permanent feature in the human minds as discussed in the theoretical part, we argue that sentiment is to be persistently reflected in the stock markets. This notion is in line with claim by Zouaoui et al (2011). Accordingly, Hypothesis 1 is drawn as follow:…”

“…This is possible through the following forces. First, the consumer confidence indices are widely available in many countries (Zouaoui, Nouyrigat, & Beer, 2011) and regularly discussed in the press as an indicator of future economic prospects (Lachowska, 2011). Second, in investment practice, market participants rely on heuristics and market sentiment (Dow, 2011).…”

The Roles of Investor Sentiment in Malaysian Stock Market

“…However, most of the research are empirical based and neglect the theoretical underpinning of investor sentiment. This causes varied definition of investor sentiment with no universally accepted measures of investor sentiment (Zouaoui et al, 2011) reflected in behavioural finance literature.…”

The early‐warning system of stock market crises with investor sentiment: Evidence from China

“…The decrease is much larger than what can be explained by changes in economic variables (Black, 1988). Zouaoui, Nouyrigat, and Beer (2011) find that the impact of investor sentiment on stock markets is more pronounced in countries that are culturally more prone to herd-like behaviour and overreaction or in countries with low institutional involvement. In 2015, the growth of GDP slowed to 6.9%, hitting a new low of 25 years.…”

“…However, only a few of studies have attempted to directly link sentiment indicators to market crises. Zouaoui et al (2011) find that investor sentiment increases the probability of occurrence of stock market crises within a 1-year horizon. Bahhouth and Maysami (2011) found that in the 2008 financial crisis, the price earnings ratio had significant predictive power to the stock risk.…”