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The impact of rational and irrational sentiments of individual and institutional investors on DJIA and S&P500 index returns

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  • Rahul Verma
  • Hasan Baklaci
  • Gokce Soydemir

Abstract

We examine the relative effects of rational and irrational investor sentiments on Dow Jones Industrial Average and S&P500 returns. The impact of rational sentiments on stock market returns is found to be greater than that of irrational sentiments. There are immediate positive responses of stock market returns to irrational sentiments corrected by negative responses in the upcoming periods. There are positive effects of past stock market returns on irrational sentiments but not on rational sentiments. The results support the economic fundamentals-based arguments of stock returns. Evidence in favour of irrational sentiments is consistent with the view that investor error is a significant determinant of stock returns.

Suggested Citation

  • Rahul Verma & Hasan Baklaci & Gokce Soydemir, 2008. "The impact of rational and irrational sentiments of individual and institutional investors on DJIA and S&P500 index returns," Applied Financial Economics, Taylor & Francis Journals, vol. 18(16), pages 1303-1317.
  • Handle: RePEc:taf:apfiec:v:18:y:2008:i:16:p:1303-1317
    DOI: 10.1080/09603100701704272
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    References listed on IDEAS

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    1. Robert B. Litterman, 1984. "Forecasting and policy analysis with Bayesian vector autoregression models," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
    2. Josef Lakonishok & Andrei Shleifer & Robert W. Vishny, 1991. "Do Institutional Investors Destabilize Stock Prices? Evidence on Herding and Feedback Trading," NBER Working Papers 3846, National Bureau of Economic Research, Inc.
    3. Robert B. Litterman, 1984. "Forecasting with Bayesian vector autoregressions four years of experience," Staff Report 95, Federal Reserve Bank of Minneapolis.
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    Cited by:

    1. Jördis Hengelbrock & Erik Theissen & Christian Westheide, 2013. "Market Response to Investor Sentiment," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 40(7-8), pages 901-917, September.
    2. Lux, Thomas, 2008. "Sentiment dynamics and stock returns: the case of the German stock market," Kiel Working Papers 1470, Kiel Institute for the World Economy (IfW).
    3. Liston, Daniel Perez, 2016. "Sin stock returns and investor sentiment," The Quarterly Review of Economics and Finance, Elsevier, vol. 59(C), pages 63-70.
    4. Hu, Zongyi & Li, Chao, 2015. "Investor Sentiment and Irrational Speculative Bubble Model," MPRA Paper 62108, University Library of Munich, Germany.
    5. Pablo Calafiore & Gökçe Soydemir & Rahul Verma, 2010. "The Impact of Business and Consumer Sentiment on Stock Market Returns: Evidence from Brazil," Chapters,in: Handbook of Behavioral Finance, chapter 18 Edward Elgar Publishing.
    6. Yamamoto, Ryuichi & Hirata, Hideaki, 2013. "Strategy switching in the Japanese stock market," Journal of Economic Dynamics and Control, Elsevier, vol. 37(10), pages 2010-2022.
    7. Sayim, Mustafa & Rahman, Hamid, 2015. "An examination of U.S. institutional and individual investor sentiment effect on the Turkish stock market," Global Finance Journal, Elsevier, vol. 26(C), pages 1-17.
    8. Thomas Lux, 2011. "Sentiment dynamics and stock returns: the case of the German stock market," Empirical Economics, Springer, vol. 41(3), pages 663-679, December.

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