Investor Sentiment in the Stock Market

Abstract

Investor sentiment, defined broadly, is a belief about future cash flows and investment risks that is not justified by the facts at hand. The question is no longer whether investor sentiment affects stock prices, but how to measure investor sentiment and quantify its effects. One approach is "bottom up," using biases in individual investor psychology, such as overconfidence, representativeness, and conservatism, to explain how individual investors underreact or overreact to past returns or fundamentals. The investor sentiment approach that we develop in this paper is, by contrast, distinctly "top down" and macroeconomic: we take the origin of investor sentiment as exogenous and focus on its empirical effects. We show that it is quite possible to measure investor sentiment and that waves of sentiment have clearly discernible, important, and regular effects on individual firms and on the stock market as a whole. The top-down approach builds on the two broader and more irrefutable assumptions of behavioral finance -- sentiment and the limits to arbitrage -- to explain which stocks are likely to be most affected by sentiment. In particular, stocks that are difficult to arbitrage or to value are most affected by sentiment.

Anomalies and Investor Sentiment: Empirical Evidences in the Brazilian Market

“…Table 8 shows the significance and the relation of the index changes. The anomalies that are significant in the CAPM, and persist even when the three-factor and four-factor models are used, corroborate Baker and Wurgler (2007), which provided a greater efficiency for the index changes to explain returns more frequently. Note.…”

“…This tendency may not reflect investor sentiment, but rather a decrease in transaction costs that took place over the years (Baker & Wurgler, 2006). To detrend the TURN, this work applied the same procedure used in international works (Baker et al, 2012;Baker & Wurgler, 2006, 2007, that is, turnover was considered the difference between the current value and the moving average of the previous three years. This procedure causes the TURN variable to represent the turnover variation on the average of the previous three years; thus, it may be a negative value.…”

“…The premise that investor sentiment has a significant impact on determining stock values has been used in a number of studies that analyze the relationship between returns and an investor sentiment index, producing evidence that sentiment does have an influence on stock prices (Baker & Wurgler, 2006, 2007Baker, Wurgler, & Yuan, 2012;Barberis, Shleifer, & Vishny, 1998;Brown & Cliff, 2004;Delong, Shleifer, Summers, & Waldmann, 1990;Shiller, 2000;Stambaugh et al, 2012;Yu, 2013;Yu & Yuan, 2011).…”

“…In this context, a number of studies have found empirical evidence that investor sentiment can possibly contain a vast market component capable of driving the prices of several assets at once towards a specific direction (Baker & Wurgler, 2006, 2007Baker et al, 2012;Brown & Cliff, 2004;Stambaugh et al, 2012;Yu & Yuan, 2011).…”

“…The growing literature consolidates a consensus that investor sentiment affects stock prices, thus driving researchers to a new issue, that of seeking the best ways to measure sentiment (Baker & Wurgler, 2007 Economists view sentiment measures obtained through surveys with some suspicion, since there is a potential distance between what respondents say and their behavior (Baker & Wurgler, 2007). Another approach uses secondary data of investor transactions as proxies for sentiment.…”