The importance of fear: investor sentiment and stock market returns
The presence of investor sentiment pushes asset prices away from the equilibrium level justified by underlying fundamentals. While sentiment is not directly observable, identifying appropriate proxies and, quantifying the impact of sentiment on asset prices is an important topic. Asset prices that d...
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| Format: | Journal Article |
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Routledge
2017
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| Online Access: | http://hdl.handle.net/20.500.11937/51532 |
| _version_ | 1848758721767800832 |
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| author | Smales, Lee |
| author_facet | Smales, Lee |
| author_sort | Smales, Lee |
| building | Curtin Institutional Repository |
| collection | Online Access |
| description | The presence of investor sentiment pushes asset prices away from the equilibrium level justified by underlying fundamentals. While sentiment is not directly observable, identifying appropriate proxies and, quantifying the impact of sentiment on asset prices is an important topic. Asset prices that do not appropriately reflect fundamental values may result in inefficient allocation of capital – impacting portfolio allocation decisions and the cost of capital. Utilizing a number of sentiment proxies, over the period 1990–2015, we demonstrate a strong relationship between investor sentiment and stock returns that is consistent with theoretical explanations of sentiment. We determine that implied volatility index (VIX) is the preferred measure of sentiment in terms of improving model fit and adding explanatory power. Causality tests suggest that investor fear (VIX) drives returns across firm-size and value, and also across industry. We also illustrate that firms that are more subjective to value, or face limits to arbitrage, such as small-cap stocks, or those in the business equipment (technology) or telecoms industry, are most responsive to changes investor sentiment. Finally, we demonstrate that sentiment has a greater influence on market returns during recession, when sentiment is at its lowest ebb, and this is particularly true for those stocks most susceptible to speculative demand. |
| first_indexed | 2025-11-14T09:48:30Z |
| format | Journal Article |
| id | curtin-20.500.11937-51532 |
| institution | Curtin University Malaysia |
| institution_category | Local University |
| last_indexed | 2025-11-14T09:48:30Z |
| publishDate | 2017 |
| publisher | Routledge |
| recordtype | eprints |
| repository_type | Digital Repository |
| spelling | curtin-20.500.11937-515322017-09-13T15:41:43Z The importance of fear: investor sentiment and stock market returns Smales, Lee The presence of investor sentiment pushes asset prices away from the equilibrium level justified by underlying fundamentals. While sentiment is not directly observable, identifying appropriate proxies and, quantifying the impact of sentiment on asset prices is an important topic. Asset prices that do not appropriately reflect fundamental values may result in inefficient allocation of capital – impacting portfolio allocation decisions and the cost of capital. Utilizing a number of sentiment proxies, over the period 1990–2015, we demonstrate a strong relationship between investor sentiment and stock returns that is consistent with theoretical explanations of sentiment. We determine that implied volatility index (VIX) is the preferred measure of sentiment in terms of improving model fit and adding explanatory power. Causality tests suggest that investor fear (VIX) drives returns across firm-size and value, and also across industry. We also illustrate that firms that are more subjective to value, or face limits to arbitrage, such as small-cap stocks, or those in the business equipment (technology) or telecoms industry, are most responsive to changes investor sentiment. Finally, we demonstrate that sentiment has a greater influence on market returns during recession, when sentiment is at its lowest ebb, and this is particularly true for those stocks most susceptible to speculative demand. 2017 Journal Article http://hdl.handle.net/20.500.11937/51532 10.1080/00036846.2016.1259754 Routledge restricted |
| spellingShingle | Smales, Lee The importance of fear: investor sentiment and stock market returns |
| title | The importance of fear: investor sentiment and stock market returns |
| title_full | The importance of fear: investor sentiment and stock market returns |
| title_fullStr | The importance of fear: investor sentiment and stock market returns |
| title_full_unstemmed | The importance of fear: investor sentiment and stock market returns |
| title_short | The importance of fear: investor sentiment and stock market returns |
| title_sort | importance of fear: investor sentiment and stock market returns |
| url | http://hdl.handle.net/20.500.11937/51532 |