Investor sentiment, risk factors and stock return: evidence from Indian non‐financial companies
17 Aug 2012-Journal of Indian Business Research (Emerald Group Publishing Limited)-Vol. 4, Iss: 3, pp 194-218
Abstract: Purpose – The purpose of this paper is to evaluate the pricing implication of aggregate market wide investor sentiment risk for cross sectional return variation in the presence of other market wide risk factors.Design/methodology/approach – The paper employs the Fama and French time series regression approach to examine the impact of market risk premium, size, book‐to‐market equity, momentum and liquidity as risk factors on stock return. Given the importance of inherent imperfect rationality or sentiment risk, the paper further investigates the impact of investor sentiment on the cross section of stock return.Findings – The choice of a five factor model is apparently persuasive for consideration in investment decisions. Stocks are hard to value and difficult to arbitrage with characteristics which are significantly influenced with the sentiment risk. It is naive to argue for the universal pricing implication of sentiment risk in a multifactor model framework.Research limitations/implications – The test as...
Topics: Financial risk management (63%), Security market line (63%), Risk premium (60%), Liquidity risk (60%), Risk management (56%)
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Abstract: The study investigated that whether the relationship between macroeconomic fluctuations and stock indexes is symmetrical or asymmetrical in nature. This study employed nonlinear autoregressive dist...
17 citations
Cites methods from "Investor sentiment, risk factors an..."
...…are examined only by using linear models (Black et al., 2015; Chen et al., 2012; Gregoriou et al., 2015; Inoguchi, 2014; Khan et al., 2017; Saumya, 2012; Shakil et al., 2018; Tiwari et al., 2015; Zaheer, 2019; Khalil et al., 2018) and no effort was made to find out nonlinear impact of…...
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Abstract: Purpose – The purpose of this paper is to analyze the asymmetric contemporaneous relationship between implied volatility index (India VIX) and Equity Index (S & P CNX Nifty Index). In addition, the study also analyzes the seasonality of implied volatility index in the form of day-of-the-week effects and option expiration cycle. Design/methodology/approach – This study employs simple OLS estimation to analyze the contemporaneous relationship among the volatility index and stock index. In order to obtain robust results, the analysis has been presented for the calendar years and sub-periods. Moreover, the international evidenced presented for other Asian markets (Japan and China). Findings – The empirical evidences reveal a strong persistence of asymmetry among the India VIX and Nifty stock index, at the same time the magnitude of asymmetry is not identical. The results show that the changes in India VIX occur bigger for the negative return shocks than the positive returns shocks. The similar kinds of result...
15 citations
Abstract: Purpose – The aim of this study is to examine the “volatility smile” or/and “skew”, term structure and implied volatility surfaces based on those European options written in the standard and poor (S&P) Nifty equity index. The stochastic nature of implied volatility across strike price, time-to-expiration and moneyness violates the core assumption of the Black–Scholes option pricing model. Design/methodology/approach – The potential determinants of implied volatility are the degree of moneyness, time-to-expiration and the liquidity of the strikes. The empirical work has been expressed by means of a simple ordinary least squares (OLS) framework and presents the estimation results according to moneyness, time-to-expiration and liquidity of options. Findings – The options data give evidence of the existence of a classical U-shaped volatility smile for the Indian options market. Indeed, there is some evidence that the “volatility smirk” which pertains to 30-day options and also implied volatility remain higher...
13 citations
Cites background from "Investor sentiment, risk factors an..."
...There is a substantial body of work (Dash and Mahakud, 2012; Chandra, 2012; Kumar and Pandey, 2013; Shaikh and Padhi, 2013; and Padhi and Shaikh, 2014) that deals with market efficiency, stock returns and capital flow, investor sentiment and the information content of option prices....
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Abstract: In this paper, we experiment with the construction of alternative investor sentiment indices. Further, we evaluate the role of the sentiment-based factor in asset pricing to explain prominent equity market anomalies such as size, value, and price momentum for India. Based on the findings, we confirm that our Composite Sentiment index leads other sentiment indices currently in vogue in investment literature. The asset pricing models, including the more recent Fama French 5 factor model, are not fully able to explain the small firm effect which is captured by our sentiment-based factor which seems to proxy for the price over-reactions.
12 citations
Cites background or methods from "Investor sentiment, risk factors an..."
...Dash and Mahakud (2012) also developed a sentiment index from the market related proxies and confirmed the unidirectional causal relationship between sentiment index and the two benchmark market indices in India....
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...The expected signs of the sentiment proxy variables (see table 3) used to construct the 3 variants of the sentiment indices are in conformity with the theory and existing empirical literature (refer Baker and Wurgler, 2006) and Dash and Mahakud, 2012)....
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...…with their lag which can be attributed to the fact these two are firm supply response variable to aggregate sentiment in the market which are expected to lag behind proxies that are based directly on investor demand or investor behavior (refer Baker and Wurgler, 2006 and Dash and Mahakud, 2012)....
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...Following Baker and Wurgler (2006) and Dash and Mahakud (2012), we regress these standardized proxies against the market variables as shown below: Senti,t= α+ β1,i IIP+ β2,i FX+ β3,iWPI+ β4,i M3 + β5,i TERM+ β6,i FII+ β7,i D+ εi,t (1) In this regression, Senti,t is one of the many sentiment proxies…...
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...In accordance with existing literature (Baker and Wurgler, 2006 and Dash and Mahakud, 2012), the list of macroeconomic variables used for this purpose alongwith their description and data sources, is given in Exhibit 2....
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Abstract: This paper participates in the debate on market efficiency and correct approach for asset pricing through a comprehensive review of literature in favor, as well as against the long held belief of market efficiency. The purpose of this paper is to understand emerging trends in behavioral finance and establish its future potential as a mainstream alternative theory of asset pricing.,The review and discussion of literature is mainly divided into three different sections that are –theories supporting efficient market hypothesis (EMH); studies providing evidences from the stock market on the failure of EMH and studies on behavioral finance, discussing separately investors’ behavioral biases keeping in mind their effect on stock prices; and providing empirical evidences on the effect of investor sentiment on stock prices.,The review of literature from both the point of views has helped in understanding the market efficiency issue and changing dynamics of asset pricing approach. This is achieved by highlighting the gaps in the concept of market efficiency and also suggesting how these gaps can be bridged with a superior approach such as behavioral finance. Through further discussion of emerging trends in behavioral finance, the paper also points out gaps and how these can be abridged, for behavioral finance to be accepted as a mainstream alternative approach to EMH.,This is an extensive and one of a kind study that discusses market efficiency through discussion of EMH and behavioral finance side by side. With the help of such a study, researchers can precisely understand the need and can focus on the future course of action to make behavioral finance a mainstream approach to asset pricing.
12 citations
References
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Abstract: This paper presents a critique of expected utility theory as a descriptive model of decision making under risk, and develops an alternative model, called prospect theory. Choices among risky prospects exhibit several pervasive effects that are inconsistent with the basic tenets of utility theory. In particular, people underweight outcomes that are merely probable in comparison with outcomes that are obtained with certainty. This tendency, called the certainty effect, contributes to risk aversion in choices involving sure gains and to risk seeking in choices involving sure losses. In addition, people generally discard components that are shared by all prospects under consideration. This tendency, called the isolation effect, leads to inconsistent preferences when the same choice is presented in different forms. An alternative theory of choice is developed, in which value is assigned to gains and losses rather than to final assets and in which probabilities are replaced by decision weights. The value function is normally concave for gains, commonly convex for losses, and is generally steeper for losses than for gains. Decision weights are generally lower than the corresponding probabilities, except in the range of low prob- abilities. Overweighting of low probabilities may contribute to the attractiveness of both insurance and gambling. EXPECTED UTILITY THEORY has dominated the analysis of decision making under risk. It has been generally accepted as a normative model of rational choice (24), and widely applied as a descriptive model of economic behavior, e.g. (15, 4). Thus, it is assumed that all reasonable people would wish to obey the axioms of the theory (47, 36), and that most people actually do, most of the time. The present paper describes several classes of choice problems in which preferences systematically violate the axioms of expected utility theory. In the light of these observations we argue that utility theory, as it is commonly interpreted and applied, is not an adequate descriptive model and we propose an alternative account of choice under risk. 2. CRITIQUE
34,961 citations
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"Investor sentiment, risk factors an..." refers background in this paper
...(Kahneman and Tversky, 1979), and limited arbitrage in determining stock prices (Brown and Cliff, 2005; Shleifer and Vishny, 1997)....
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24,566 citations
Abstract: This paper identities five common risk factors in the returns on stocks and bonds. There are three stock-market factors: an overall market factor and factors related to firm size and book-to-market equity. There are two bond-market factors. related to maturity and default risks. Stock returns have shared variation due to the stock-market factors, and they are linked to bond returns through shared variation in the bond-market factors. Except for low-grade corporates. the bond-market factors capture the common variation in bond returns. Most important. the five factors seem to explain average returns on stocks and bonds.
22,909 citations
"Investor sentiment, risk factors an..." refers background in this paper
...In recent years, following the theoretical argument of multifactor model specification (Merton, 1973; Ross, 1976) and motivated with the characteristic based risk pricing, the three factor (Fama and French, 1993), and four factor model (Carhart, 1997) have been widely debated and acclaimed in asset pricing literature to explain the cross section of average stock returns....
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Abstract: This paper describes a simple method of calculating a heteroskedasticity and autocorrelation consistent covariance matrix that is positive semi-definite by construction. It also establishes consistency of the estimated covariance matrix under fairly general conditions.
17,401 citations
Abstract: One of the problems which has plagued thouse attempting to predict the behavior of capital marcets is the absence of a body of positive of microeconomic theory dealing with conditions of risk/ Althuogh many usefull insights can be obtaine from the traditional model of investment under conditions of certainty, the pervasive influense of risk in finansial transactions has forced those working in this area to adobt models of price behavior which are little more than assertions. A typical classroom explanation of the determinationof capital asset prices, for example, usually begins with a carefull and relatively rigorous description of the process through which individuals preferences and phisical relationship to determine an equilibrium pure interest rate. This is generally followed by the assertion that somehow a market risk-premium is also determined, with the prices of asset adjusting accordingly to account for differences of their risk.
17,152 citations