Investor Sentiment And Its Effect On Stock Returns

In the real stock market, some of the characteristics of the asset price behavior of traditional financial theory framework didn’t have a reasonable explanation, but behavioral finance theory provided a new perspective to interpret these visions. In this context, investor sentiment and its relationship with the asset price behavior was becoming a hot issue for the field of behavioral finance. Behavioral finance theory suggested that the process of investor sentiment prevalent in investors’trading activities, and ultimately had an impact on asset prices. At present, behavior on investor sentiment and its impact on asset prices had made many achievements, but there were some problems existed. Therefore, further study on this issue would help us to deeply understand the behavior of asset price, and had important theoretical and practical significance.This paper mainly studied investor sentiment problems to the stability of the measure, and on this basis to study the relationship between investor sentiment and asset price behavior, and particularly relates to investor sentiment affect the market volatility of specific mechanisms, as well as investor sentiment’s impact in relation between fluctuations and incomes. The content of this study and innovation could be summarized as the following three aspects:First, the traditional principal component analysis method had been used to construct a composite sentiment indicator, and we focused on the robustness of investor sentiment under the different sentiment indicators and different principal components. Especially, the Kalman filter analysis method had been used to build a new composite indicator of investor sentiment, and we compared this new composite indicator with the one that was formed by the principal component analysis method, and further validated the robustness of the composite indicators of investor sentiment. These methods could prove that the investor sentiment which was built by this paper had a considerable degree of robustness.Secondly, under the GARCH model and realized volatility of the two types of volatility models, this paper reverified the impact of fluctuations in investor sentiment conclusion of the study, and confirmed that investor sentiment could make the volatility rise in the market. And contrapose to the theoretical status quo of the fact that the investor sentiment affected the market volatility was not clear, this paper first decomposed the market fluctuations, and found that market volatility could be decomposed into the product of the average correlation and average variance, and this decomposition was valid and was not affected by investor sentiment. On the basis of the market volatility decomposition, this paper had built a mechanism model of investor sentiment affects market volatility, and done some study on how investor sentiment could affect the market volatility. The empirical results shown that, the overall impact of investor sentiment on market fluctuations was through the affect of the average variance, but investor sentiment on the average correlation with the opposite effected and played a certain amendments role.Finally, combined with the market volatility decomposition, this paper, starting from the point of the relation between return and volatility was to study the effect of investor sentiment on the expected return of the market. First, through a dummy variable regression we found that investor sentiment would affect the relationship between fluctuations in income, the higher the investor sentiment was, the more weakened the relationship between fluctuations and income, or even become negative correlation. Next, with the Roll the Critical, this paper used the average correlation to instead of the overall risk to re-examine the impact of investor sentiment on the relationship between the return and fluctuate, the empirical results shown that the basic conclusion which the investor sentiment could impact the relationship between the return and fluctuate was still correct, and the average correlation had significant predictive ability on the expected return of the stock market.Our study provided a new perspective to study the relationship between investor sentiment and the stock market return characteristics, which developed the existing investor sentiment theory and the behavioral finance theory. In this paper, we also provided new ideas for investors’ practices and related departments’ policy development, which had its important practical value.