Investor Sentiment and Stock Returns: Evidence from Romania

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1 Inernaional Journal of Academic esearch in Accouning, Finance and Managemen Sciences Vol. 4, No.2, April 2014, pp E-ISSN: , P-ISSN: HMAS Invesor Senimen and Sock eurns: Evidence from omania Dragoș Șefan OPEA 1 Laura BAD 2 1,2 Buchares Universiy of Economic Sudies, 1 opreadragossefan@yahoo.com, 2 laura_brad2004@yahoo.com, 2 laura.brad@fin.ase.ro Absrac Key words The aiude of individual invesors is srongly correlaed wih heir senimen, so heir behavior on he sock marke can generae imporan changes in price flucuaions. The aim of our sudy was o provide evidence regarding he relaionship beween he evoluion of sock marke and he individual invesor senimen, proxy by he consumer confidence index. This sudy is conduced on he Buchares Sock Exchange (BSE) for a 10 year ime period, saring from 2002 o 2011 and includes 120 observaions. The resuls proved ha here is a posiive correlaion beween changes in consumer confidence and sock marke reurns, demonsraing ha individual invesor senimen affecs sock prices. However, he influence of individual invesor senimen seems o be quickly removed by he force of arbirage. The price adjusmens are realized in less han a monh. Moreover, he influence of individual invesor senimen on he prices of he mos 10 liquid companies from BSE is no saisically significan. Invesor senimen, noise, arbirage, consumer confidence, Buchares Sock Exchange DOI: /IJAAFMS/v4-i2/764 UL: hp://dx.doi.org/ /ijaafms/v4-i2/ Inroducion The general finding of senimen reurn relaionship is no in accordance wih he Efficien Marke Hypohesis (Fama 1970) which saes ha he sock prices reflec he discouned value of expeced cash-flows and he effec of irraional marke paricipans in sock prices are removed by he raional paricipans. However, he behavioural finance suggess ha irraional senimen (overly opimisic/pessimisic expecaions abou invesmen risk and fuure cash flow; Chang e al. 2009) can persis and affec sock prices for significan periods of ime. Baker and Wurgler (2006) sae ha sock mispricing is based on uninformed demand shocks induce by irraional invesors and limis o arbirage. Brown and Cliff (2005) claim ha senimen could be a very persisen effec so, he demand shocks of irraional raders could be correlaed over ime leading o a srong and persisen mispricing. The limis of arbirage preven raional raders o eliminae his influence on sock prices since i is unclear how long he buying or selling pressure from overly opimisic or pessimisic irraional raders will persis (Shleifer and Vishny, 1997). However, every mispricing mus evenually be correced so ha one should observe ha high levels of invesor opimism (pessimism) are on average followed by low (high) reurns (Schmeling, 2009). Earlier evidence, Brown and Cliff (2005), do indeed showed ha here is a negaive senimen reurn relaionship in he case of U.S. sock marke. This paper invesigaes he impac of individual invesor senimen (hereafer, invesor senimen) in he prices of socks lised on he omanian sock marke. Firs of all, we analyzed he conemporaneous relaionship beween changes in invesor senimen and sock marke reurns. We observed ha changes in invesor senimen and sock marke reurns are posiively correlaed. This finding suggess ha invesor senimen affecs sock prices. The increase of individual invesor opimism leads o an increase in sock prices. The effec is reversed when pessimism grows. Secondly, we concluded ha he impac of invesor senimen is sronger in he case of small socks han large socks. Thirdly, we invesigaed he relaion beween he curren invesor senimen level and he fuure sock marke reurn. In his way we could

2 Inernaional Journal of Academic esearch in Accouning, Finance and Managemen Sciences observe he lengh of he period in which raional invesors remove he influence of irraional raders on sock prices. The resul is surprising. The raional invesors remove he impac of irraional raders in less han a monh. 2. Lieraure review A large body of lieraure has provided empirical evidence abou he relaionship beween invesor senimen and sock price. Sudies ha are focused on he ime-series relaionship beween invesor senimen and sock price repor ha he curren invesor senimen predics lower fuure sock reurns. Fisher and Saman (2000) find ha he American Associaion of Individual Invesors senimen index (proxy for individual/small invesor senimen) and Wall Sree sraegiss senimen (proxy for insiuional/large invesor senimen) are negaively correlaed wih he S&P 500 reurn in he following monh. In a laer sudy, Fisher and Saman (2003) examine wheher he consumer confidence index is a good proxy for he individual invesor senimen and if he consumer confidence index predics sock reurns. Their resul shows ha changes in consumer confidence index were accompanied by saisically significan changes in he individual invesor senimen abou he sock marke. The conemporaneous relaionship beween changes in consumer confidence and S&P 500 reurns is posiive. Also, Fisher and Saman (2003) observe ha high consumer confidence is in general followed by low fuure S&P 500, NASDAQ and small sock reurns. Brown and Cliff (2004), using differen proxies for invesor senimen, noe ha he senimen level and change are posiively and srongly correlaed wih he conemporaneous sock marke reurn. Also, Brown and Cliff (2004) es he causal 1 relaionship beween senimen level/change and sock reurn. I was suggesed by hem (Brown and Cliff (2004)) ha he sock marke reurn is a good predicor of individual and insiuional invesor senimen in he shor run. Charoenrook (2005) uses he Universiy of Michigan Consumer Senimen Index o invesigae is explanaory power for sock marke reurn and find ha he changes in consumer senimen are posiively relaed o he conemporaneous excess marke reurns and negaively relaed o he fuure excess reurns a one-monh and one-year horizons. Using differen senimen proxies, Wang, Keswani and Taylor (2006) observe ha heir invesor senimen proxies are caused by sock reurns and volailiy raher han vice versa (in accordance wih Brown and Cliff, 2004). Canbaş and Kandir (2009) obained similar resuls for he Turkish sock marke. The pas sock reurns clearly predic fuure level of invesor senimen. Similar, Schmeling (2009), in an inernaional pooled analysis, suggess ha here is wo-way causaliy such ha invesor senimen depends on previous reurns and he reurns depend on previous invesor senimen. Due o lack of specific indicaors consruced o measure he senimen of individual invesors, in he inernaional conex, mos empirical ess employ he consumer confidence index o proxy for invesor senimen (see, for insance, such an argumenaion in Schmeling 2009). Schmeling (2009) remarks ha he invesor senimen is a conrarian indicaor for he fuure sock marke reurn across counries. High (low) invesor senimen ends o be followed by lower (higher) sock reurns. Also, Schmeling (2009) noes ha he negaive impac of invesor senimen diminish as he forecas horizon of marke reurn is increased. In economic erms, he decline of he invesor senimen impac suggess ha he noise rading effecs 2 in sock prices vanish over long ime periods. In he shor period, here are limis o arbirage, bu in he medium and long run, he arbirage becomes sronger. This evidence is in accordance wih a heoreical poin of view. As Schmeling (2009) claims, an opposie finding would mean ha he noise rade demand shocks move he sock prices permanenly away from equilibrium. The evidence above reveals hree disincive senimen-reurn relaionships. Firsly, he posiive relaionship beween changes in invesor senimen and sock reurns proves ha he sock prices end o be overvalued (undervalued) in a bullish (bearish) marke, especially when he excessive opimism (pessimism) of invesors is unjusified by fundamenals and here are limis o arbirage. Secondly, he negaive relaionship 1 Causaliy in he saisically sense of Granger 2 Black (1986) reveals ha on he marke are some invesors who rade on noise as if i is informaion associaed wih fundamenals. The individual invesors are considered o be he noisy invesors on he marke (Lee, Shleifer, and Thaler 1991). According o Shleifer and Summers (1990), he invesors who based heir rades on noise, are no oally raional and heir demand for risky asses is influenced by heir beliefs or by heir senimens which are no fully jusified by fundamenal values. 20

3 Inernaional Journal of Academic esearch in Accouning, Finance and Managemen Sciences beween curren invesor senimen and fuure sock reurns suggess ha he prices end o rever o heir fundamenal values afer gradual correcions. Finally, he relaion beween invesor senimen and reurn is no very clear in he sense ha he noise rade approach sae ha he senimen cause he sock reurns, bu some empirical es (Brown and Cliff, 2004; Wang, Keswani, and Taylor, 2006; Canbaş and Kandir, 2009) show ha sock reurns cause invesor senimen. From anoher angle, some sudies invesigae he influence of individual invesor senimen on differen caegories of socks. Baker and Wurgler (2006) argue ha he socks ha are harder o arbirage and whose valuaions are highly subjecive are more likely o be affeced by changes in individual invesor senimen. 3 Lee, Shleifer and Thaler (1991) sae ha small socks are owned, in principal, by individual invesors, peoples which are more likely o rade on noise, as opposed o insiuional invesors. As such, when he senimen of noise raders is changing, he prices of small socks could be influenced more han he prices of large socks. Kumar and Lee (2006) find ha he individual invesors buy or sell socks in concer (heir rading sraegies are sysemaically correlaed). Brown and Cliff (2005) observe ha he invesor senimen has a sronger effec for growh han for value socks. Baker and Wurgler (2006) show ha he invesor senimen has similar impac for boh value and growh socks. Finally, Lemmon and Porniaguina (2006) provide evidence ha senimen has a significan effec for value, bu no for growh socks. Schmeling (2009) obained similar resuls according wih Lemmon and Porniaguina (2006). As we can observed, mix resuls are repored in he field, bu no proper relevance of hem has been realized upon he omanian marke, which is essenially our aim for his research. To be in line wih he lieraure developed so far, we based our research on hree hypoheses: H1: If he individual invesor senimen affecs he sock prices hen he conemporaneous relaionship beween change in individual invesor senimen and sock marke reurn should be posiive. H2: The influence of individual invesor senimen on prices is sronger in he case of socks for which valuaion is subjecive and hey are hard o arbirage, such as small socks. H3: The influence of individual invesor senimen on sock prices is miigaed by he raional invesors, so a negaive correlaion beween he curren level of invesor senimen and fuure sock reurns should be observed. 3. Daabase and mehodology of research In order o es our hypoheses, we colleced he necessary daa for he period For invesor senimen, he proxy ha we ook ino consideraion was he consumer confidence index (see, for insance, Schmeling, 2009). This indicaor is measured on a scale ha has values beween -100 and 100 and i s a qualiaive variable calculaed using survey daa. I was aken from he sie of European Commission: hp://ec.europa.eu/index_ro.hm. This indicaor has only negaive levels. As a fac, in order o reveal is impac on sock marke reurn and o be in accordance wih he lieraure in he field, modificaions upon i have been realized. Firsly, we inversed i and secondly, we calculaed he absolue value: abs 1, (1) Where: is he level of consumer confidence index in monh. These mahemaical ricks have been applied in order o susain and o provide proper inerpreaion. 3 Baker and Wurgler (2006) sugges ha he socks of companies wih shor and insable earnings hisory and wih an apparenly unlimied growh opporuniies deerminae individual invesors o consruc a large specrum of valuaions, according o heir senimen. In conras, he value of a company wih a long and sable earnings hisory, sable dividends is less subjecive (Baker and Wurgler, 2007). Also, some papers show ha arbirage ends o be more risky and cosly for young, small (in erms of capializaion), unprofiable, exreme growh firms and socks of financial disressed companies (Wurgler and Zhuravskaya, 2002; Amihud and Mendelsohn, 1986). 21

4 Inernaional Journal of Academic esearch in Accouning, Finance and Managemen Sciences To quanify he omanian sock marke evoluion, we used he indexes from he Buchares Sock Exchange (BSE). Boh, he Buchares Exchange Trading Composie index (BET-C) and he Buchares Exchange Trading index (BET) were used, he firs one as a measure for he evoluion of he enire sock marke and he second one, as a proxy for he evoluion of he mos liquid socks which are, in general, he bigges in erms of marke capializaion. BET-C is a marke capializaion weighed index. BET-C is he mos comprehensive index of socks and reflecs he evoluion of all companies lised on he firs and second caegory on he BSE regular marke. BET reflecs he price movemens of he mos liquid socks quoed on he BSE. The source of index daa was he BSE websie: As daa for consumer confidence index usually appears a he end of he monh, for reliable and comparable daa, we also ook he level of BET and BET-C a he end of each monh for he accouned period. In order o es our hypoheses, he reurn of sock indexes was calculaed as follow: P P i, i, 1 i. (2) Pi, 1 Where: i, represen he realized reurn of sock index in monh, P i, is he las index level in monh and P i,-1 is he las index level in monh -1. Also, he change of consumer confidence index was compued as follow: abs, abs, 1 G (3) abs, 1 Where: G is he change of consumer confidence index in monh. In order o es our firs and second hypohesis (H1 and H2), we esimaed he following regressions: BET C, 0 1 G u (4) BET, 0 1 G v (5) Where: BET-C, is he realized reurn of BET-C index (proxy of he sock marke reurn) in monh, BET, is he realized reurn of BET index (proxy of he reurns of large socks) in monh, G is he change of consumer confidence index in monh, u and v are residual erms. In order o es he hird hypohesis (H3), we esimaed he following regressions: BET C, 2 3 abs, 1 w (6) BET, 2 3 z (7) abs, 1 Where: BET-C, is he realized reurn of BET-C index (proxy of he sock marke reurn) in monh, BET, is he realized reurn of BET index (proxy of he reurns of large socks) in monh, abs, is he absolue value of he inverse level of consumer confidence index in monh (see, also, relaion (1)), w and z are residual erms esuls and discussion As i was poined ou before, he aim of his research is o observe if he individual invesor senimen, measured hrough consumer confidence, affecs he prices of sock lised on he omanian sock marke (H1).

5 Inernaional Journal of Academic esearch in Accouning, Finance and Managemen Sciences The resul of his analysis is provided in Table 1. Also, he influence of invesor senimen could be sronger in he case of socks which are hard o value and arbirage, like small socks (H2). Table 1 repors he resul of his invesigaion. Table 1. The invesor senimen and sock prices Elemen EQ-(4) NW Elemen EQ-(5) NW Inercep Inercep * G ** G squared squared F saisic ** F saisic Noes: Table 1 presens he resuls obained afer he esimaion of equaion (4) and (5). We analyzed he presence of heeroscedasiciy and auocorrelaion in he residual erms during he esimaion of regressions. The heeroscedasiciy was esed by he Whie heeroscedasiciy es (Whie, 1980) and he serial correlaion was verified by he Breusch Godfrey Lagrange muliplier es (Breusch, 1978; Godfrey, 1978). If we deeced only he heeroscedasiciy, we applied he correcion proposed by Whie (1980) and if errors were auocorrelaed, we applied he correcion proposed by Newey and Wes (1987) (see Brooks, 2008, p. 152). NW indicaes ha he -saisics are correced for heeroscedasiciy and auocorrelaions wih Newey Wes procedure. * and ** indicaes significan a he 1% and 5% levels, respecively. Our firs hypohesis is confirmed. The invesor senimen affecs he prices of sock lised on he omanian sock marke. The change of invesor senimen is posiively relaed o he sock marke reurn in conemporaneous erms (EQ-(4)). An increase of he invesor senimen leads o an increase in sock prices. The effec is reversed for a decrease in invesor senimen. Moreover, he irraional invesors buy and sell in concer affecing he enire sock marke. As such, invesor senimen has an impac on aggregae omanian sock marke. However, he quesion is if he invesor senimen influences differen ypes of socks in he same way and wih he same power. Lee, Shleifer and Thaler (1991) argue ha small socks are owned by individual invesors, peoples ha are more likely o be affeced by senimens. As such, when he senimen of individual raders is changing, he prices of small socks could be influenced more han he prices of large socks. The resul obained afer he esimaion of equaion (5) suggess ha he impac is differen. In paricular, our finding is ha he invesor senimen ends o have no influence on he prices of large socks. Therefore, invesor senimen seems o have an impac on he prices of small socks. Similar resuls were obained by Schmeling (2009) in an inernaional framework. The invesor senimen proves o have an impac on sock prices in he case of omanian sock marke. Furhermore, in principal, he prices of small socks are affeced. However, from a heoreical poin of view, he impac of invesor senimen should be removed by he raional invesor rough he arbirage operaion. Indeed, Schmeling (2009) shows ha he forces of arbirage work and he effec of invesor senimen in sock prices is wash ou in long periods of ime. The resul of our analysis, however, suggess ha he impac of invesor senimen in sock prices seems o be removed very quickly. This evidence is repored in Table 2. Table 2. Arbirage vs. invesor senimen Elemen EQ-(6) NW Inercep * abs, squared F saisic Noes: Table 2 presens he resuls obained afer he esimaion of equaion (6). We analyzed he presence of heeroscedasiciy and auocorrelaion in he residual erms during he esimaion of regression. The heeroscedasiciy was esed by he Whie heeroscedasiciy es (Whie, 1980) and he serial correlaion was verified by he Breusch Godfrey Lagrange muliplier es (Breusch, 1978; Godfrey, 1978). If we deeced only he heeroscedasiciy, we applied he correcion proposed by Whie (1980) and if errors are auocorrelaed, we applied he correcion proposed by Newey and Wes (1987) (see Brooks, 2008, p. 152). NW indicaes ha he - saisics are correced for heeroscedasiciy and auocorrelaions wih Newey Wes procedure. * and ** indicaes significan a he 1% and 5% levels, respecively. 23

6 Inernaional Journal of Academic esearch in Accouning, Finance and Managemen Sciences The esimaed coefficien of consumer confidence ( abs,-1 ) is negaive, bu no saically significan. As such, he relaionship beween he curren sock marke reurn and previous level of invesor senimen is negaive. This finding suggess ha he raional invesors miigae he influence of irraional invesors led by senimens. Moreover, because he esimaed coefficien is no saisically significan, we can conclude ha he impac of invesor senimen is erased by raional invesors in less han a monh Conclusions The aim of his sudy was o provide evidence abou he relaionship beween sock prices and individual invesor senimen. We decided o use he consumer confidence index as a proxy for invesor senimen since, as for omania no specific indicaor is consruced o measure he senimen of individual invesors. The resuls showed ha indeed, he sock prices seem o be affeced by he invesor senimen. Moreover, i appears ha he invesor senimen has a significanly impac on he prices of small socks, as i does no influence he price of socks of he mos en liquid omanian companies which are, in general, he bigges in erm of marke capializaion. These finding are somehow similar wih he findings of Schmeling (2009). Also, we showed ha he forces of arbirage are working in he conex of omanian sock marke. The impac of invesor senimen appears o be miigaed and removed by he raional invesors in less han a monh. This evidence is surprising, because Schmeling (2009) observed ha he impac of invesor senimen is removed over long period of ime. One limiaion of our sudy is ha we used only one proxy for he invesor senimen. Oher sudies used various measures of invesor senimen. For insance, Baker and Wurgler (2006) argued ha he urnover raio of sock marke reflecs he invesor senimen. Also, his sudy did no invesigae he impac of invesor senimen simulaneous wih he influence of fundamenal facors. Furher research should be direced o provide evidence abou he influence of invesor senimen, proxy by more han one variable (consumer confidence index). Also, he impac of invesor senimen should be analyzed simulaneous wih he influence of fundamenal facors like macroeconomic variables. Acknowledgemens This work was cofinanced from he European Social Fund hrough Secoral Operaional Programme Human esources Developmen , projec number POSDU/107/1.5/S/77213 Ph.D. for a career in inerdisciplinary economic research a he European sandards. eferences 1. Amihud, Y., Mendelson, H. (1986). Asse pricing and he bid-ask spread. Journal of Financial Economics, 17(2), Baker, M., Wurgler, J. (2006). Invesor senimen and he cross-secion of sock reurns. Journal of Finance, 61(4), Baker, M., Wurgler, J. (2007). Invesor senimen in he sock marke. Journal of Economic Perspecives, 21(2), Black, F. (1986). Noise. The Journal of Finance, 41(3), Breusch, T.S. (1978). Tesing for Auocorrelaion in Dynamic Linear Models. Ausralian Economic Papers, 17(31), Brooks, C. (2008). Inroducory Economerics for Finance, second ediion, Cambridge Universiy Press, New York. 7. Brown, G. W., Cliff, M. T. (2005). Invesor Senimen and Asse Valuaion. Journal of Business, 78(2), Brown, G. W., Cliff, M. T. (2004). Invesor senimen and he near-erm sock marke. Journal of Empirical Finance, 11(1), Canbaş, S., Kandır, S. Y. (2009). Invesor Senimen and Sock eurns: Evidence from Turkey. Emerging Markes Finance and Trade, 45(4),

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