Do Indian stock market sentiments impact contemporaneous returns?

Abstract

PurposeThe purpose of this paper is to analyse the impact of Indian investor sentiments on contemporaneous stock returns of Bombay Stock Exchange, National Stock Exchange and various sectoral indices in India by developing a sentiment index.Design/methodology/approachThe study uses principal component analysis to develop a sentiment index as a proxy for Indian stock market sentiments over a time frame from April 1996 to January 2017. It uses an exploratory approach to identify relevant proxies in building a sentiment index using indirect market measures and macro variables of Indian and US markets.FindingsThe study finds that there is a significant positive correlation between the sentiment index and stock index returns. Sectors which are more dependent on institutional fund flows show a significant impact of the change in sentiments on their respective sectoral indices.Research limitations/implicationsThe study has used data at a monthly frequency. Analysing higher frequency data can explain short-term temporal dynamics between sentiments and returns better. Further studies can be done to explore whether sentiments can be used to predict stock returns.Practical implicationsThe results imply that one can develop profitable trading strategies by investing in sectors like metals and capital goods, which are more susceptible to generate positive returns when the sentiment index is high.Originality/valueThe study supplements the existing literature on the impact of investor sentiments on contemporaneous stock returns in the context of a developing market. It identifies relevant proxies of investor sentiments for the Indian stock market.