Role of sentiments in stock market

Financial professionals always have an eye on the impact of investors’ psychology and sentiments on the stock returns in the financial markets. The media constantly discusses and analyses the effect of investors’ mood on stock market movements. Mr. Daniel Kahneman stated in his speech on ‘Psychology and Market’ at Northwestern University in 2000 that ‘If you listen to financial analysts on the radio or on TV, you quickly learn that the market has a psychology. Indeed, it has character. It has thoughts, beliefs, moods, and sometimes stormy emotions’. Several research studies explain that there exists a strong relationship between stock prices in the market and the investors’ sentiments (Black, 1986; De Long, Shleifer, Summers and Waldmann, 1990; Barberis, Shleifer and Vishny, 1998; Daniel, Hirshleifer and Subrahmanyam, 2001).

According to De Long et al. (1990), investors can be categorized into sentiment-free rational investors (arbitrageurs) and extraordinary sentimental irrational investors. The latter group of investors affects the pricing mechanism in the stock market. Their psychological perception and the sentiments even affect the liquidity, future and growth of the capital market. It will decide whether a public issue would be fully, over or under-subscribed (Michael. S. Ogunmuyiwa, 2010). According to the empirical studies being conducted since early 20th century, investors’ sentiments can be measured either directly through surveys or indirectly by depending upon the sentiment related objective variables (Lee, Shleifer and Thaler, 1991; Neal and Wheatley, 1998; Brown and Cliff, 2004). One can conclude that the sentiments of the investors are very crucial in the determination and the anticipation of the stock market crisis (Mohamed ZOUAOUI, Geneviève NOUYRIGAT & Francisca BEER, 2010). Even different grades of sentiments will affect different types of stocks at different levels (Malcolm Baker and Jeffrey Wurgler, 2007).

Priya Chetty

Partner at Project Guru
Priya is a master in business administration with majors in marketing and finance. She is fluent with data modelling, time series analysis, various regression models, forecasting and interpretation of the data. She has assisted data scientists, corporates, scholars in the field of finance, banking, economics and marketing.

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  1. The role investors sentiments in stock market: the investors are behaved exuberantly or under-reacted rather than behaved rationally. It is observed in the stock market that on the listing day, the IPOs have positive returns and after a month of listing, the IPOs fall down and indulge in the declining stage. The positive return of the IPO means the investors are earned more profits from their investments and this stage is referred as overperformance of IPO. But, the pre IPO market gives the option to the investors to speculate on new come up issues rather than herding. The investors behaved exuberantly when the price of the IPOs is more from the issue price of IPO. On the Initial day of IPO, sometimes the investors behaver over optimistically or invested blindly which results in a wrong decision in future. The overly exuberant investors are ready to pay too much on the high listing price of the IPO. This means high demand of investors for that IPO shares. this behavior temporarily pushed the IPO price more than the issue price and inbestors earned positive returns but followed by the negative returns or crashed recorded after some time in that IPO. It is suggested to the investors try to behave rationally and make right investment decision after the careful analysis of IPO company fundamentals which discloses from IPO grading, company fundamentals, choose their preferences of better performed sectors which provide better returns consistently.

  2. I have submitted to topics on market efficiency and investors sentiments for IPO shares.
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