Abstract
This paper tried to utilize Ensemble Empirical Mode Decomposition (EEMD) to explore the correlations between investor sentiment and stock index and macro economy, as well as the prediction capacity of the short-term fluctuation, medium-term fluctuation and long-term trend of investor sentiment in the future stock market return. Firstly, dynamic factor model (DFM) was used to extract sentiment factors from 5 proxy variables of investor sentiment. Then, characteristics comparison and lead-lag relationship analyses were made on the short-term fluctuation, medium-term fluctuation and long-term trend of investor sentiment index, Shanghai Stock Index and macro index. Finally, whether the original signals of investor sentiment and each component can predict the size and the direction of future market returns was tested. Results indicated that high-frequency sentiment signals had a significant reverse prediction capacity on the short-term and medium-term future market returns. Moreover, low-frequency sentiment signals had a stronger prediction capacity in the direction of future market returns than original sentiment signals, high-frequency sentiment signals and residual signals.
Highlights
In the behavioral financial theory, investor sentiment is a core concept as well as a research hotspot in the present academic field and practice field
Results indicated that investor sentiment had no significant influence on the short-term return of the stock market while it had a significantly negative correlation with the future 1 - 3 years’ return rate of the stock market
The results indicated that the higher the investor sentiment was, the smaller future market returns was and the higher the possibility of future negative market returns was
Summary
In the behavioral financial theory, investor sentiment is a core concept as well as a research hotspot in the present academic field and practice field. Many literatures made empirical tests on whether investor sentiment could predict future stock or market returns. Results found that the loser portfolio presented a high return while the winner portfolio presented a low return This phenomenon was called winner-loser effect, indicating that momentum factor was an effective investor sentiment measurement which could effectively predict the future return of the investment portfolio. Results indicated that investor sentiment had no significant influence on the short-term return of the stock market while it had a significantly negative correlation with the future 1 - 3 years’ return rate of the stock market. The correlations between the short-term fluctuation, medium-term fluctuation and long-term trend of investor sentiment and stock index and macro economy as well as their prediction capacity on future stock market returns were investigated
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