Asymmetric Relationship between Investors' Sentiment and Stock Returns: Evidence from a Quantile Non‐causality Test

• Published date: 01 December 2017
• Author: Haiqi Li,Yu Guo,Sung Y. Park
• Date: 01 December 2017
• DOI: http://doi.org/10.1111/irfi.12120

Asymmetric Relationship between

Investors’Sentiment and Stock

Returns: Evidence from a Quantile

Non-causality Test*

HAIQI LI

†,‡

,YUGUO

†

AND SUNG Y. PARK

§

†

College of Finance and Statistics, Hunan University, Changsha, China,

‡

Department of Economics, Cornell University, Ithaca, NY, USA and

§

School of Economics, Chung-Ang University, Seoul, Korea

ABSTRACT

This study investigates the causal relationship between investor sentiment

and stock returns in the USA by conducting a quantile Granger non-

causality test. Employing two proxies for investor sentiment –the sentiment

index developed by Baker and Wurgler in 2007 and the University of Michigan

Consumer Survey,a consumer confidence index –we find that the causal rela-

tionship between investor sentiment and stock returns strengthens when a

tail quantile interval is considered. This finding implies that the investor

sentiment could provide the incremental predictability for the stock returns

under the extreme market situation, which cannot be found using a

traditional Granger causality test. Interestingly, the findings can be explained

by investors’loss aversion and herding behavior.

JEL Codes: C12; G14; G15

I. INTRODUCTION

The relationship between investor sentiment and stock returns is an important

topic in the field of behavioral finance. A growing body of research has recently

examined the role of investor sentiment in the predictability of stock returns;

however, there is no consensus on the issue in the literature. For example, Baker

and Wurgler (2006) argued that the pattern of stock return predictability of inves-

tor sentiment varied by stock characteristic (e.g., firm size, volatility, and age).

Chung et al. (2012) found that the predictive power of investor sentiment was

generally significant in the expansionary state, but non-significant in the reces-

sionary state. Kim and Kim (2014) found no evidence concerning the return

* We would like to thank the editor and an anonymous referee for many pertinent comments and

suggestions. However, we retain the responsibility for any remaining errors. This project was sup-

ported by the National Natural Science Foundation of China (NSFC) (no. 71301048) and the Natural

Science Foundation of Hunan province in China (no. 14JJ3053).

© 2017 International Review of Finance Ltd. 2017

International Review of Finance, 2017

DOI: 10.1111/irfi.12120

International Review of Finance, 17:4, 2017: pp. 617–626

DOI: 10.1111/irfi .12120

© 2017 International Review of Finance Ltd. 2017