The Effect Of Investors’ Sentiment On Stock Price

Traditional financial theory based on two basic assumptions:completely efficient market hypothesis and the rational behavior hypothesis. In practice, however, more and more phenomena turn out that, traditional finance theories are invalid, when trying to explain them. There are a large number of anomalies in financial market. To explain these anomalies, scholars introduce the theory of Psychology and Sociology into Finance theory. Therefore, Behavioral Finance is created.Experts in Behavioral Finance believe that investors in market are not entirely rational. Irrational behaviors will bring unusual fluctuations in stock price, making prices deviate from their fundamental values. This factor leading to price deviation is called "investors sentiments", which is one of the systemic risks that makes stock price change, and the important factor affecting the price.Above this context, firstly, this paper introduces noise trading model, using this model to reveal the mechanism that how the "investors sentiments" affects the stock price. Then use principal component method to analyze these four indicators:closed-end fund discount rates, volumes, turnovers, and numbers of new accounts in each week, and then extracting them to represent a proxy of investors sentiments. Comparing with the Shanghai Composite Index in weeks, we can find their relevance. At last, use GARCH models to analyze their specific relevance in the quantitative analysis.The result shows that:given the Shanghai Composite Index in weeks, changes in investors sentiments significantly affect not only returns, but also significantly reversely correct risks(earnings volatility). This conclusion provides the quantitative support for our theoretical point, that is,"investors sentiments" is indeed a systemic factor to affect financial asset prices and fluctuations in returns.