Using E-GARCH to Analyze the Impact of Investor Sentiment on Stock Returns Near Stock Market Crashes.

Sze Ting Chen,Kai Yin Allison Haga

doi:10.3389/fpsyg.2021.664849

Sze Ting Chen, Kai Yin Allison Haga

Open Access

https://doi.org/10.3389/fpsyg.2021.664849

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Abstract

Purpose: Investor sentiment, the willingness of market participants to invest, is a difficult concept to measure. Exploring the relationship between investor sentiment and stock returns can reveal how investor sentiment affects the operation of the stock market. Such an understanding can assist market participants in making more rational investment decisions based on market laws. Such an understanding can also assist regulators in their roles of supervision and policy making.Methodology: Although the E-GARCH model has the advantage of considering volatility clustering, it has not previously been used to investigate the impact of investor sentiment changes on the Shanghai Composite Index's market return. This research therefore applies the E-GARCH approach to data from 2015 to 2018, to explore the influence of investor sentiment on the return rate of the Shanghai Composite Index.Main Findings: There are three main findings. First, when the investor sentiment is increased by the same amount, the rate of return before a stock market crash will have a smaller increase than the rate of change after the crash, which is a new finding. Second, the rate of return on stocks is susceptible to emotional sentiment, rather than simply depending on stock price. Third, the tendency of retail investors to follow the crowd is less in periods of pessimism than it is in periods of optimism, which, in turn, can push up stock yields.Application: Based on these research results, this article can provide insights to understand how investors' subjective judgments on future earnings affect their investment behavior and how great the impact is on the market. At the same time, it can help investors make more rational investment decisions based on an understanding of market laws, and help regulators with guidance for their supervision and policy making.Originality/Value: This paper contributes to the theory of the investor sentiment index, improving the index construction method by adding two sentiment proxy indicators: investor activity ACT and stock market leverage level. After constructing the sentiment index and comparing it with the stock market index (Shanghai Composite Index), the fit is found to be improved.

Highlights

In July 2020, the “China Securities Journal” pointed out that China’s A-share market “is necessary and conditional to enter a healthy bull market,” which would be necessary for promoting economic recovery, attracting foreign investment and competing with other countries
This paper improves the index construction method by adding two sentiment proxy indicators: investor activity ACT and stock market leverage level and find that the coefficient before the stock market crash was smaller than that after the stock market crash, in comparing an increase in investor sentiment vs. an -sized decrease, the sentiment increase had less effect on the market rate of return before a stock market crash than the decrease had after a crash
The EGARCH model did not reject the null hypothesis that the residual sequence is white noise, which supports that the model estimation is well-realized

Summary

Introduction

In July 2020, the “China Securities Journal” pointed out that China’s A-share market “is necessary and conditional to enter a healthy bull market,” which would be necessary for promoting economic recovery, attracting foreign investment and competing with other countries. The current bull market in China is driven by liquidity/policies, with capital flowing from bonds and bank deposits into stocks. Without strong corporate earnings support, market sentiment would tend to be fragile. Several factors are potential risks for severe market volatility: disappointing economic data in the second half of the year, corporate earnings in the second quarter and guidance for the second half of the year, geopolitical risks and potential sanctions brought about by Sino-US trade war negotiations and/or political turmoil in Hong Kong, worsening floods in China, and a second wave virus outbreaks (Feng and Liu, 2020). Unlike the 2015 Ashare bull market (driven by leverage and margin financing), local investors have -far continued to store funds in the market, given that China’s domestic bond yields and deposit rates have fallen

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