Progress Of the Study on The Impact of Investor Sentiment on Stock Returns

Abstract

Traditional pricing models do not reckon investor sentiment as a systematic factor of stock returns. However, past market events around the world have shown considerable return anomalies that are unexplainable by well-known market factors alone. It has inspired researchers to develop behavioral finance, that is, the study of investor irrationality and how it influences the stock market in a less efficient setting. This essay reviews three popular methods to research the impact of investor sentiment on stock returns in stock markets: conventional regression models, the GARCH model family, and the DSSW model, proposed by De Long et al. It is found that conventional regressions links investor sentiment with a significant effect on stock returns, with different patterns that reflect past data and predict future prices. The GARCH family explores the sentiment-return relationship in more detail, considering factors such as volatility, while the DSSW model gives a more behavioral account and captures the complexity of such patterns of effect. In the research of this paper, investor sentiment does influence stock returns as well as volatility in both markets, which implies a deeper understanding of the stock markets and calls for attention of retail investors, institutional investors, and financial regulators.