Role of sentiments in stock market

By Priya Chetty on February 8, 2011

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).


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