Investor sentiment and global economic conditions

Abstract

The paper examines the macroeconomic relevance of the common component of discount rate news in firm-level stock returns for G7 countries (except for Italy, focusing on each country’s index constituents) by applying a hierarchical dynamic factor model to the Campbell and Ammer (1993) return decomposition. This approach offers advantages over alternative investor sentiment indicators and is easily extended to a larger cross-section of countries. Evidence suggests global investor sentiment leads, rather than lags, domestic sentiment and global economic conditions. Investor sentiment predicts economic conditions in-sample and out-of-sample.