On the impact of sentiment on stock returns: the case of Dhaka Stock Exchange

Since frontier markets are dominated by less-informed individual investors, the stock price movements of these markets could be influenced by the sentiment of general investors. This paper investigates the effect of sentiment on the returns of the Dhaka Stock Exchange (DSE), the main stock exchange in Bangladesh. The study uses indirect measures of stock market sentiment. Results show that sentiment impacts contemporaneous returns, followed by some corrections in the next month. Contrary to general belief, large firms are more vulnerable to market sentiment. There is a unidirectional (Granger) causality from market turnover to portfolio returns, and a strong bi-directional causal relationship between moving average changes and stock returns. When conditional volatility is considered, a significant impact of sentiment is observed, mainly on small-size portfolios. In the presence of other market-wide risk factors, sentiment factors reasonably explain individual stock returns. Overall, the study concludes that sentiment should be considered as a source of systematic risk for the firms listed in the DSE.