Does investor sentiment really matter?

We examine the role sentiment plays and its manifestation in the trading behavior of investors in the U.S. stock market. Our findings support the notion that sentiment-induced buying and selling is an important determinant of stock price variation. While ‘classical’ asset pricing categorizes investors who trade in ways not consistent with mean-variance optimization as ‘irrational,’ we show that this traditional view should not hastily be evoked to characterize sentiment-driven investing. We instead show that sentiment-driven investors can trade against the herd and sell when prices are overinflated as a result of over-bullishness and vice versa. The asset pricing implications of this paper are that sentiment is linked to shifts in risk tolerance and this triggers contrarian-type behavior. In sum, we uncover the following regarding the behavior of sentiment-driven investors; firstly, they are more apt to trade on survey-based indicators rather than market-based indicators. Secondly, they trade on the basis of information extracted from individual, rather than institutional, investor surveys. Thirdly, they respond asymmetrically to shifts in sentiment and trade more aggressively during periods of declining sentiment. Finally, there is asymmetry in the role of sentiment with respect to business conditions whereby such buying and selling is more pronounced during bear markets

Political Uncertainty and Stock Market Volatility in the Middle East and North African (MENA) Countries

This paper examines the impact of political uncertainty (caused by the civil uprisings in the Arab World i.e., “Arab Spring”) on the volatility of major stock markets in the MENA region. Our main findings are as follows. First, by distinguishing between conventional and Islamic stock market indices, we find that these two groups of investments react heterogeneously to the recent political turmoil. Specifically, we document a significant increase in the volatility of Islamic indices during the period of political unrests whereas the uprisings have had little or no significant effect on the volatility in conventional markets. Such difference is confirmed by further analysis in a multivariate GARCH model. Second, regardless of its impact on volatility, there is little evidence to suggest that MENA markets have become more integrated with international markets after the political revolution. Third, similar results are not found for the benchmark indices which indicate that the changes are the result of political tensions. In general, these results are robust to model specification and consistent with the notion that political uncertainty contributes to financial volatility. Overall, the findings are important in understanding the role of political uncertainty on stock market stability and are of great significance to investors and market regulators

Business cycle variation in positive feedback trading : evidence from the G-7 economies

Using the business cycle indicators and the aggregate stock market data, this paper examines the degree of positive feedback trading in the G-7 economies and the extent to which such behaviour varies across business cycle. The evidence suggests that there is a significant positive feedback trading in the major stock exchanges of G-7 countries and its intensity is linked to the overall macroeconomic conditions. Specifically, our investigation reveals that in expansions there is more active positive feedback trading than in recessions. Overall, our results yield an important insight into the effect of business cycle on investors’ behaviour and market dynamics and bear important implications for the investment professions and market regulators

Does Linkage Fuel the Fire? The Transmission of Financial Stress across the Markets

This paper develops an indicator of financial stress transmission, called Financial Stress Spillover Index (FSSI), to monitor the condition of financial system and to identify periods of excessive spillover that may lead to financial instability. Specifically, using the “spillover index” approach of Diebold and Yilmaz (2012), we modify and extend the financial stress indices proposed by Oet et al., 2011 to track both total and directional stress spillovers across the U.S. equity, debt, banking, and foreign exchange markets. Unlike other previous studies, the important linkages among these four major financial sectors in an interconnected world are directly taken into account by considering the average and time-varying connectedness of each individual market. The evidence suggests that there are important stress episodes and fluctuations across markets; the total cross-market stress spillovers were rather limited until the onsets of financial crises. As the crises intensified, so too did the financial stress spillovers; with significant stress carrying over from debt and equity markets to the others. In addition, our results indicate that FSSI has a significant predictive power for the economic activity and provides useful information for dating financial crisis

Volatility Transmission across Commodity Futures Markets

Sharp movements in crude oil prices and their impact on other commodities have renewed interest in the assessment of dynamic interactions between commodity futures markets. This chapter examines this topic by investigating the intensity and direction of volatility transmission across three major classes of commodities, including agricultural products (corn, coffee, and soybeans), energy (crude oil and gas), and metals (copper, gold, and silver). Overall, the evidence suggests that important volatility episodes and fluctuations exist across major commodity markets; the total cross-market spillovers are limited until the onset of financial crisis of 2007–2008. As the crisis intensified, so too did the commodity volatility spillovers, with substantial stress carrying over from the energy and metal markets to others. These findings are important in understanding the level and transmission mechanism of risk across commodity futures markets and are relevant to regulators in formulating policies to tackle excessive volatility, particularly during turbulent periods

Investor Sentiment and Feedback Trading: Evidence from the Exchange-Traded Fund Markets

This paper extends the standard feedback trading model of Sentana and Wadhwani (1992) by allowing the demand for shares by feedback traders to depend on sentiment. Our empirical analysis of three largest Exchange-Traded Fund (ETF) contracts in the U.S. suggests that there is a significant positive feedback trading in these markets and the intensity of which is generally linked to investor sentiment. Specifically, the level of feedback trading tends to increase when investors are optimistic. In addition, we find that the influence of sentiment on feedback trading varies across market regimes. These results are consistent with the view that feedback trading activity is largely caused by the presence of sentiment-driven noise trading. Overall, the findings are important in understanding the role of sentiment in investment behaviour and market dynamics and are of direct relevance to the regulators and investors in ETF markets

Determinants of Capital Structure: An Empirical Investigation of Malaysian Listed Government Linked Companies (GLCs)

In this study, we explore how the debt equity choices of Listed Malaysian Government linked Companies (GLCs) are influenced by the firm specific characteristics and macroeconomic variables using a sample of 13 GLCs from 1997 to 2009. Two elements of leverage, book value of total debt ratio (BVTDR) and long term debt ratio (BVLTDR), were used to check for any significant changes in corporate financing and found mixed results. Tangibility and firm size are the most significant variables to determine the corporate financing of GLCs. Liquidity and interest rate are negatively significant with BVTDR and BVLTDR, respectively.The study concluded that profitability is inconsequential in determining corporate financing; inconsistent with the findings of previous Malaysian studies. With the proper design of capital structure and intervention from the government, the study also concludes that GLCs are rely less on leverage to support their investment activities