Research On The Relationship Between Investor Sentiment And Stock Returns Based On The Method Of PLS

Security market in China is still immature as well as the laws, regulations, supervision and investors’ structure haven’t been constructed properly giving rise to frequent irrational phenomenons of most retail investors’ participation. In that case, the classical finance principles are not applicable any more so this thesis will start from this point aiming to explore the influence of sentiment on stock market returns. First, this thesis compares the predictive power of PCA with a more efficient manner PLS and then explore how the sentiment affect the stock’s yield in different exchanges, boards and industries at different periods of time. What’s more, this thesis will do integration analysis of comparing predictability of investor sentiment with economic predictors.The construction of investors’ sentiment is the basis of this study and it’s also the foundation of the empirical analysis throughout this thesis. This thesis select partial least squares(PLS) method to construct Investor sentiment index(SPLS) and compare it to investor sentiment index constructed by principal component method(SPCA). Both of these two methods select turnover rate(HSL), closed fund discount rate(DCEF), new investors’ accounts(NIA) and consumer confidence index(CCI) as individual investor sentiment proxies.According to empirical results, the conclusions are as follows. First, the coefficient of SPLS is positive because with the improvement of investor sentiment, the return of stock market goes up. Second, SPLS performs better than SPCA in almost all of the empirical results that means the partial least squares principal method is better than principal component method. Third, the empirical results of economic predictors demonstrate that SPLS contains more forecasting information than the rest of other economic predictors. Last but not at least, investor sentiment has different impacts on different industries: Computer industry is the most predictable by investor sentiment, while bank and extractive industry are the lowest.In conclusion, Chinese stock market is irrational and investor sentiment is one of the factors that significantly influence the stock value. When investors choosing invest strategies, they need to take full consideration of investor sentiment to get extra yield by taking advantage of investor sentiment.