Climatic change and epidemic disease
could influence the investor sentiment. Under such circumstances, how to invest
the stock market in different stock market states (bull, bear or neutral) is an
important topic for investors. To capture the investor sentiment more
precisely, we use principal component analysis to analyze some investor
sentiment indicators, and then form a composite index of investor sentiment.
These investor sentiment indicators include the turnover rate, the percent
change in margin borrowing, the percent change in short interest, net buy/sell,
the turnover ratio of major institutional investors, psychological line, and
advance decline ratio. Then we construct regression models to investigate the
influences of investor sentiment on the current returns and on the near-term
future returns in the different market states, respectively. The empirical
results revealed that investor sentiment indicators have significantly positive
effect on stock returns during total period, bull market and neutral market.
Among these market states, bull market has the greatest influence. When the
market is an upward tendency, investors will be willing to put funds into the
stock market. When the funds flow in, it occurs Bandwagon effect easily, so
that the stock price deviates from the reasonable price.
JEL classification numbers: E22, G30, P34
Keywords: Investor Sentiment,
Principal Component Analysis, Stock Returns, Market states.