A Reappraisal of the Causal Relationship between Sentiment Proxies and Stock Returns

Pedro Manuel Nogueira Reis · Carlos Pinho

28 citations0/0 files storedJournal of Behavioral Finance

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Financial Markets and Investment Strategies Financial Risk and Volatility Modeling Stock Market Forecasting Methods

Abstract

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.

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References

1979Prospect Theory: An Analysis of Decision under Risk 1991Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations 2009How to do Xtabond2: An Introduction to Difference and System GMM in Stata 2003Analysis of Panel Data 2006Investor Sentiment and the Cross‐Section of Stock Returns 2012Testing for Granger non-causality in heterogeneous panels 2007Giving Content to Investor Sentiment: The Role of Media in the Stock Market 2020Integración de los mercados financieros Latinoamericanos por medio de MILA

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