logo

Market Sentiment and Stock Returns Introduction

12 Pages3606 Words311 Views
   

Added on  2020-01-28

About This Document

Investor sentiment and stock returns Introduction 1 Traditional Financial Theory 2 Empirical Approach 2 Role of investor sentiment in the financial market 3 Measuring Sentiments 5 Sentiment affects stock returns 7 Using sentiment to predict stock Returns 9 Conclusion 10 References 12 Introduction Market sentiment can be defined as the overall attitude or feelings of investors towards a particular security or larger financial market. Herein, researcher aim evaluating the fact by making comparative study on the traditional and empirical studies of financial theory in which traditional financial theory claims that, sentiments

Market Sentiment and Stock Returns Introduction

   Added on 2020-01-28

ShareRelated Documents
Investor Sentiment and Stock Returns
Market Sentiment and Stock Returns Introduction_1
Table of ContentsIntroduction..........................................................................................................................................1Traditional Financial Theory.......................................................................................................2Empirical Approach.....................................................................................................................2Role of investor sentiment in the financial market......................................................................3Measuring Sentiments..................................................................................................................5Sentiment affects stock returns....................................................................................................7Using sentiment to predict stock Returns....................................................................................9Conclusion..........................................................................................................................................10References..........................................................................................................................................12
Market Sentiment and Stock Returns Introduction_2
INTRODUCTIONMarket sentiment can be defined as the overall attitude or feelings of investors towards aparticular security or larger financial market. In other words, it is a changing psychology ofindividual or investors on the basis of price movements of the securities traded in the certainmarket (Baker, Wurgler and Yuan, 2012). Herein, researcher aim evaluating the fact by makingcomparative study on the traditional and empirical studies of financial theory in which traditionalfinancial theory claims that, sentiments has no role in financial market while empirical theoryillustrates that there is a significant role of investor sentiments in financial market. Many events have occurred in the past where prices rose very high consequently creatinga bubble and eventually the market crashed. The most significant were: the Great Crash (1929),the Tronics Boom (early 1960s), the Nifty fifty bubble (early 1970s), the Black Monday crash(October 1987), the Internet bubble (1990s). Stock prices had a dramatic change. The changecould be explained through behavioral finance as the standard model failed to do so. It suggestedthat investors are subject to sentiment, as backed up by the assumptions of Delong, Shleifer,Summers and Waldmann (1990), and that betting against sentimental investors is costly andrisky because of limits to arbitrage (Da, Engelberg and Gao, 2015). Traditional Financial TheoryOn the basis of traditional financial theory, the world and its participants are consideredas the rational wealth maximizers. However, according to this theory, investors know each andevery aspect about the stock market and the company in which are they are planning to invest. Inthis situation, rational is considered more powerful than the sentiments which indeed indicatesthat, there is no major role of sentiments for the investors in making decisions in the financialmarket. However, it has been seen often that emotions and psychology influences our decisionswhich leads individual to behave in unpredictable manner or irrational ways (Stambaugh, Yu andYuan, 2014).Furthermore, under traditional financial theory, investors considers efficient markethypothesis which is an investment theory that states it is impossible to beat the market becausestock market efficiency causing existing share price to always incorporate and reflect all relevantinformation or data. As per the theory of efficient market hypothesis, stocks always trade at theirfair value on the stock exchange and creating several problems for the investors to buy theundervalued stocks or sell stocks for inflated prices. However, although it becomes almost1
Market Sentiment and Stock Returns Introduction_3
impossible to outperform the entire market through the views and thoughts of experts on stockselection or market timings (Mian and Sankaraguruswamy, 2012). But the only remaining way togenerate higher returns is to buy higher riskier investments. In addition to although consideringEfficiency Market Hypothesis as the cornerstone of modern financial theory it is still highlycontroversial and often disputed. Further, whenever investors are buying or selling the securitiesthey are actually engaging in the game of chance rather than of skills (Kumar, Page and Spalt,2013). Empirical ApproachAccording to empirical approach, theory and historical anecdote both clearly indicatesthat sentiment may cause systematic patterns of mispricing. However, although it is very difficultto identify the mispricing still through means of systematic patterns evaluating the mispricingcorrections. Furthermore, mispricing is the outcome of both an uninformed demand shock and alimit on arbitrage. Therefore, individual can think of two different channels with the help ofwhich investor’s sentiment might affect the cross section of stock prices. However, in the firstsource sentimental demand shocks vary in the cross section whereas arbitrage limit are stable.While on the other hand in second channel, the hindrance of arbitrage differentiate from stock tostock by sentiment are generic (Białkowski, Etebari and Wisniewski, 2012). Role of investor sentiment in the financial marketInvestor sentiment is “a belief about future cash flows and investment risks that is notjustified by the facts at hand.” Sentiment has cross-sectional effects when sentiment-baseddemands or arbitrage constraints varies across stocks. Irrational investors, also known as noisetraders, affect stock prices by their correlated demand shocks which leads to an instantmispricing. The type of stocks affected by investor sentiment may be new, small, more volatile,unprofitable, non-dividend paying, or distressed stocks (Corredor, Ferrer and Santamaria, 2013). Furthermore, sentiment dynamics could be used to explain the cross-sectional variationamong different portfolio types, which portfolios are the most sensitive to sentiment. Investorsentiment is described as a ‘contrarian indicator’ for subsequent returns and is less likely toindicate the reason why rational arbitrageurs do not correct mispricing’s that are avoidable.Furthermore, as per the study made by Chen, Chen and Lee, (2013), indicates that thefindings generated by author are aligned with the prediction and clarity that the role of investor’ssentiment in asset pricing is important. On the basis of this study it has been analysed that,2
Market Sentiment and Stock Returns Introduction_4

End of preview

Want to access all the pages? Upload your documents or become a member.

Related Documents
Portfolio Management using Fundamental and Technical Analysis
|18
|3787
|97

Financial Investment Research Paper 2022
|7
|1565
|23

Behavioral Finance: Exploring Irrational Behaviors of Investors
|8
|1598
|485

Finance and investment docx
|6
|644
|26

Financial Accounting Theory Case Study 2022
|16
|3736
|17

Efficient Market Hypothesis and Behaviourial Finances
|7
|1879
|483