The Impact of Investor Sentiment on Stock Returns in Emerging Markets: The Case of Central European Markets

Abstract

This article studies the effect of investor sentiment on stock returns in three Central European markets: the Czech Republic, Hungary, and Poland. The results show that sentiment is a key variable in the prices of stocks traded on these markets, and has a stronger impact here than in more developed European markets. This effect is linked to stock characteristics, particularly those considered to make stocks more prone to the influence of investor sentiment. The evidence shows that the effect is not uniform across countries, since higher levels are found for Poland and the Czech Republic, thus confirming the role of country-specific factors in the impact of investor sentiment on stock prices. The results also confirm that sentiment is a twofold (global and local) phenomenon, in which the global dimension has much greater impact than the local dimension, at least in the markets considered. Finally, the article shows that sentiment does not spread, at least to any significant degree, through the movement of capital between markets. This strengthens the argument that sentiment is transmitted through a behavioral mechanism. If this argument proves correct, there is little likelihood of local regulatory action being very effective in limiting the perverse impact of asset bubbles.