The relationship between individual investor sentiment, stock return and volatility

Abstract

Purpose – The purpose of this paper is to examine the impact of Turkish individual investor sentiment on the Istanbul Stock Exchange (ISE) and to investigate whether investor sentiment, stock return and volatility in Turkey are related. Design/methodology/approach – This study used the monthly Turkish Consumer Confidence Index, published by the Turkish Statistical Institute, as a proxy for individual investor sentiments. First, Turkish market fundamentals were regressed on investor sentiments in order to capture the effects of macroeconomic risk factors on investor sentiments. Then, it used the impulse response functions (IRFs) generated from the vector autoregression (VAR) model to examine the effect of unanticipated movements in Turkish investor sentiment to both stock returns and volatility of the ISE. Findings – The generalized IRFs from VAR shows that unexpected changes in rational and irrational investor sentiment have a significant positive impact on ISE returns. This suggests that a positive investor sentiment tends to increase ISE returns. The study also documents that unanticipated increase in the rational component of Turkish investor sentiment has a negative significant effect on ISE volatility. This might indicate that investors have optimistic expectations of the economy overall with respect to market fundamentals in Turkey. This optimism can result in creating positive expectations, reducing uncertainty, and reducing the volatility of stock market returns. Research limitations/implications – The study was applied only for the period 2004-2010 on the ISE stock returns and volatility. Practical implications – Regardless, investors should know the impact of irrational investor sentiments while establishing investment strategies. The results of this study may also help policy makers stabilize investor sentiments to reduce stock market volatility and uncertainty. Originality/value – This paper adds to the limited understanding of investor sentiment impact on stock return and volatility in an emerging market context.