Essence of Investor Sentiment

Posted in Sentiment Indicators

 

Is there an essential and useful part of investor sentiment independent of any economic and financial indicators that may feed it? In their November 2012 paper entitled “Is ‘Sentiment’ Sentimental?”, Steven Sibley, Yuhang Xing and Xiaoyan Zhang decompose a widely used aggregate investor sentiment index into two components, one related and one unrelated (residual) to common business cycle variables. They then test the ability of each component to predict returns of different kinds of stocks. The sentiment index aggregates the following indicators: closed-end fund discount; market turnover; number of initial public offerings (IPO); first day return on IPOs; secondary equity issuances; and, difference in book-to-market ratios between dividend payers and non-payers. They consider the relationship of this sentiment index to six U.S. economic variables (unemployment rate, change in consumer price index, consumption growth rate, disposable personal income growth rate, industrial production growth rate and NBER recessions) and six U.S. financial variables (3-month Treasury bill yield, default spread, term spread, dividend yield, stock market volatility and stock market liquidity). Using monthly data for all variables during July 1965 through December 2010, they find that: (more…)

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