Does Investor Sentiment Predict the Near‐Term Returns of the Chinese Stock Market?

• DOI: http://doi.org/10.1111/irfi.12202
• Author: Yimei Man,Kenneth R. Szulczyk,Muhammad A. Cheema
• Published date: 01 March 2020
• Date: 01 March 2020

Does Investor Sentiment Predict

the Near-Term Returns of the

Chinese Stock Market?*

MUHAMMAD A. CHEEMA

†,‡

,YIMEI MAN

§

AND KENNETH R. SZULCZYK

¶

†

Division of Computational Mathematics and Engineering, Institute for

Computational Science, Ton Duc Thang University, Ho Chi Minh City, Vietnam

‡

Faculty of Finance and Banking, Ton Duc Thang University, Ho Chi Minh City,

Vietnam

§

School of Accounting, Finance and Economics, University of Waikato, Hamilton,

New Zealand and

¶

Department of Finance and Banking, School of Business, Curtin University, Miri,

Sarawak, Malaysia

ABSTRACT

Recent evidence on the relationship between investor sentiment and subse-

quent monthly market returns in China shows that investor sentiment is a

reliable momentumpredictor since an increase (decrease) in investor sentiment

leads to higher (lower) future returns. However, we suggest that momentum

predictability of investor sentiment originates from the boom and bust period

of 2006–2008 (the bubble period hereafter). The bubble period is characterized

by several months of sustained optimism followed by several months of sus-

tained pessimism, with the market consequently earning high (low) returns

following high (low) sentiment months. Therefore, we find a strong positive

association between investor sentiment and subsequent market returns during

the bubble period. However, investor sentiment has a negligible impact on

subsequent monthly market returns once we exclude the bubbleperiod.

JEL Codes: G12; G14

Accepted: 9 May 2018

I. INTRODUCTION

Investor sentiment is defined as investor optimism or pessimism about the

future stock prices that cannot be explained by the existing facts (Baker and

Wurgler 2006). In the literature, there is a growing consensus that investor sen-

timent is a contrarian predictor of stock market returns in the long run

* We thank Professor Ramazan Gençay, Managing Editor and the anonymous reviewer whose com-

ments/suggestions helped improve and clarify this manuscript.

© 2018 International Review of Finance Ltd. 2018

International Review of Finance, 20:1, 2020: pp. 225–233

DOI: 10.1111/irfi.12202