Does the Investor Sentiment Affect the Stock Returns in Taiwan’s Stock Market under Different Market States?

Climatic change and epidemic disease could influence the investor sentiment. Under such circumstances, how to invest the stock market in different stock market states (bull, bear or neutral) is an important topic for investors. To capture the investor sentiment more precisely, we use principal component analysis to analyze some investor sentiment indicators, and then form a composite index of investor sentiment. These investor sentiment indicators include the turnover rate, the percent change in margin borrowing, the percent change in short interest, net buy/sell, the turnover ratio of major institutional investors, psychological line, and advance decline ratio. Then we construct regression models to investigate the influences of investor sentiment on the current returns and on the near-term future returns in the different market states, respectively. The empirical results revealed that investor sentiment indicators have significantly positive effect on stock returns during total period, bull market and neutral market. Among these market states, bull market has the greatest influence. When the market is an upward tendency, investors will be willing to put funds into the stock market. When the funds flow in, it occurs Bandwagon effect easily, so that the stock price deviates from the reasonable price. JEL classification numbers: E22, G30, P34