Measures of Investor Sentiment: Who Wins the Horse Race?

Traditional research on asset pricing has focused on firm-specific and economywide factors that affect asset prices. Recently, the finance literature has turned to noneconomic factors such as investor sentiment as possible determinants of asset prices. Some researchers (e.g., Eichengreen and Mody, 1998) suggest that a change in one set of asset prices may change investor sentiment, thus triggering changes in a seemingly unrelated set of asset prices, especially in the short run, giving rise to pure contagion. Fisher and Statman (2000) and Baker and Wurgler (2006) have also recognized that investor sentiment may be an important component of the market pricing process. In fact, some studies (see, e.g., Baek, Bandopadhyaya and Du 2005) suggest that shifts in investor sentiment may explain short-term movements in asset prices better than any other set of fundamental factors. As the volume of studies that use investor sentiment to understand shifts in asset prices grows, so does the variety of investor sentiment measures. Dennis and Mayhew (2002) have used the Put-Call Ratio, Randall, Suk and Tully (2003) utilize Net Cash Flow into Mutual Funds, Lashgari (2000) uses the Barron’s Confidence Index, Baker and Wurgler (2006) use the Issuance Percentage, Whaley (2000) uses the VIX-Investor Fear Gauge, and Kumar and Persaud (2002) employ the Risk Appetite Index (RAI). A more detailed list of studies that utilize these and other investor sentiment measures appears in Exhibit 1

Bond and Stock Market Linkages: The Case of Mexico and Brazil

This paper examines the Brady bond market of two largest Latin American economies, Mexico and Brazil. Results indicate that stripped yield of each market in the very near future is determined primarily by the past yields in the respective markets. However, over a longer-term horizon the interrelationships between the bond markets and the stock markets of the two countries become important. Future yields in the Mexican bond market are affected by the current returns in the Mexican stock market, and to a certain extent the yields in the Brazilian bond market. A significant portion of the future variation in the Brazilian bond market yield is explained by current variation of the yield in Mexican bond market and the returns in the Mexican stock market. The Brazilian stock market returns play a negligible role in either bond markets

The Hedge Fund Explosion: Is the Bang Worth the Buck?

Any casual following of the financial news would reveal that hedge funds have experienced phenomenal growth, especially over the last fifteen years. In terms of numbers, there were an estimated 8000 hedge funds in 2005, up from only 500 in 1990. During this fifteen-year period assets under management have grown from an estimated $50 billion to$1.5 trillion. Moreover, the hedgefund industry has spawned a “fund of funds” business, which has slowly become the preferred way of investing in hedge funds, especially for institutional investors. Today, the number of these combination funds is estimated at about 4000. Until recently, hedge funds have been popular primarily with high-net-worth individuals. While this is true even today (individual investors make up more than half of all hedge-fund shareholders), an increasingly larger proportion of hedge-fund investors are pensions, retirement plans, endowments, and corporations. As further evidence of the growth of hedge-fund popularity, Exhibit 2 reveals that the largest pension plans doubled their stake in alternatives, including hedge funds, over a ten-year period between 1995 and 2005. As a specific example, the March 22, 2006 issue of the Boston Globe reported that hedge funds account for 5 percent of total assets of the $40 billion of the Massachusetts Pension Reserves Investment Trust. The pension fund\u27s board plans to increase that share to 10 percent by the end of this year

Who Knew: Financial Crises and Investor Sentiment

It has been argued and empirically documented that with a looming financial crisis, the risk-reward trade-off of market participant changes, resulting in a decrease in market sentiment. Traders flock towards less risky securities which drives the returns of such securities higher. In this paper, based on a methodology developed by Persaud [1996], by correlating the riskiness and returns of securities in various international equity markets, an index to measure the sentiment of market participants is constructed. We use the breaking point of the Lehman Brothers bankruptcy as the onset of the financial crisis in 2008. We track the market sentiment that we construct in months leading to the bankruptcy. We find that while market sentiment was high at the beginning of the year it started declining drastically many months prior to the bankruptcy, indicating that market participants were behaving as if a financial crises was approaching. Market sentiment remains low in a few months after the crisis, shows some improvement thereafter in anticipation of policies to address the crisis, but still remains depressed as compared to pre-crisis levels as policy makers struggle to formulate regulatory changes. The findings in this paper are consistent with an emerging strand of finance literature [see, e.g., Bezemer, 2009] which disputes the notion that the financial crisis could not be foreseen. Market participants were convinced of the impending crisis and were behaving in a manner consistent with that, even when policy makers and senior executives the financial services seemed oblivious

A Survey of Demographics and Performance in the Hedge Fund Industry

We investigate hedge fund demographics using data from the Alternative Asset Center (AAC) and then hedge fund performance over the twelve years since inception of the Credit Suisse/Tremont Hedge Fund Indices (HFI, 1994-2005). We find that hedge funds are largely domiciled “offshore” while hedge-fund managers are located primarily in the United States, particularly New York, California, Illinois, Connecticut and Florida. We find that the annualized performance of hedge funds as an “asset class” is about the same as that of U.S. equities (S&P 500). That being said, the real benefit of hedge funds lies in risk management as the volatility of HFI is considerably lower than the stock market. We also find that most hedge-fund “styles” provide solid absolute and risk-adjusted returns and conclude that hedge funds have been a worthwhile investment vehicle for fund indexers and active investors

Measuring Investor Sentiment in Equity Markets

Recently, investor sentiment has become the focus of many studies on asset pricing. Research has demonstrated that changes in investor sentiment may trigger changes in asset prices, and that investor sentiment may be an important component of the market pricing process. Some authors suggest that shifts in investor sentiment may in some instances better explain short-term movement in asset prices than any other set of fundamental factors. In this paper we develop an Equity Market Sentiment Index from publicly available data, and we then demonstrate how this measure can be used in a stock market setting by studying the price movements of a group of firms which represent a stock market index. News events that affect the underlying market studied are quickly captured by changes in this measure of investor sentiment, and the sentiment measure is capable of explaining a significant proportion of the changes in the stock market index

Measures Of Investor Sentiment: A Comparative Analysis Put-Call Ratio Vs. Volatility Index

Traditional research on asset pricing has focused on firm-specific and economy-wide factors that affect asset prices.  Recently, the finance literature has turned to non-economic factors, such as investor sentiment, as possible determinants of asset prices (see for example, Fisher and Statman 2000 and Baker and Wurgler 2006).  Studies such as Baek, Bandopadhyaya and Du (2005) suggest that shifts in investor sentiment may explain short-term movements in asset prices better than any other set of fundamental factors.  A wide array of investor sentiment measures are now available, which leads us quite naturally to the question of which measure best mirrors actual market movements.   In this paper, we begin to address this question by comparing two measures of investor sentiment which are computed daily by the Chicago Board Options Exchange (CBOE) and for which historical data are freely available on the CBOE website, thus making them ideal for use by both academics and practitioners studying market behavior: the Put-Call Ratio (PCR) and the Volatility Index (VIX).  Using daily data from January 2, 2004 until April 11, 2006, we find that the PCR is a better explanatory variable than is the VIX for variations in the S&P 500 index that are not explained by economic factors.  This supports the argument that, if one were to choose between these two measures of market sentiment, the PCR is a better choice than the VIX

Down But Not Out: The Future of the Financial Services Industry

The financial services industry is a key sector of the U.S. economy. It is a noteworthy contributor to the overall gross domestic product and is an important component of the gross state product for many states. With the downturn in the economy at the beginning of this decade and the accompanying declines in stock market values, the industry has been hit hard. Asset management firms have experienced sharp decreases in their assets under management; banks and insurance companies have had to refocus their operations and have become increasingly vulnerable to acquisition. As evidence grows stronger that it is unlikely that fund managers will outperform market indexes consistently, many have started questioning the value of active asset management, thus jeopardizing the role of many players in the industry. This report provides a look at the financial services industry, including recent developments and future trends

Managing Exchange Rates

The collapse of the fixed exchange rate system established under the Bretton Woods Agreement ushered in fluctuating exchange rate regimes. Although extreme volatility is managed by monetary authorities, fluctuations in exchange rates present unique challenges to the manager of a multinational corporation (MNC). This chapter reviews various types of exchange rate regimes and discusses the types of risk an MNC faces due to exchange rate fluctuations. Special attention is paid to how these risks are measured and ways in which they are hedged using available financial market instruments. The chapter also discusses exchange rate forecasting models that are frequently used

ADR Characteristics and Performance in International and Global Indexes

This study looks at the characteristics and performance of ADRs in international and global indexes. We find that ADRs in EAFE are tilted toward three common factors: giant cap, high dividend yield, and U.K. stocks. In terms of risk-adjusted performance, we find that ADRs provide inefficient diversification for US investors, as tradeoffs of return and risk are better with portfolio combinations of the S&P500 and the S&P Global 700, as compared with portfolio combinations of the S&P500 and an ADR breakout of the Global 700. Our findings on ADR characteristics are consistent with prior research, while our performance findings are inconsistent with prior research which points to ADR portfolio efficiency