Investor Sentiment and Investment Decision-Making

Abstract

We develop an investor sentiment index that captures the investor behaviour and analyses its suitability in explaining asset prices after augmenting it in multifactor asset pricing models. Seven different proxies including Sensex P/E ratios, dividend premium, modified advances to declines ratio, number of new equity issues, ratio of total equity issues to total equity and debt issues, turnover of BSE and volatility premium have been utilized. The investor sentiment index thus created mimics the movement of Sensex. Investor sentiment finds significance in explaining the returns for most of the portfolio under the different multifactor models. Fama–French three-factor model again lags in explaining the portfolio returns while Carhart four-factor model and residual momentum factor model match in performance for explaining stock returns.