Investor Sentiment and Stock Market Volatility: Evidence from India

ABSTRACT

In this article, the authors probe the role of irrational investor sentiment in the determination of Indian stock market volatility. The authors developed a new irrational aggregate sentiment index (IASI) to examine the issue. The conditional volatility is extracted from the nonlinear univariate models for the market indices and the IASI. The vector autoregression (VAR) is carried out to analyze the relationship between the volatility of irrational aggregate sentiment index and stock market volatility. The authors find a unidirectional causality from sentiment to stock market volatility, and their findings highlight the significance of sentiment in explaining the stock market volatility in India.

KEYWORDS:

• conditional heteroskedasticity
• investors’ sentiment
• Irrational investors
• noise traders
• stock market volatility
• vector autoregression (VAR)

Acknowledgments

We acknowledge the constructive comments and suggestions of anonymous referees.

Notes

1. See Daniel et al. (1998) and Hirshleifer (2001) for the summary of investor psychology and asset price volatility.

2. See Barberis et al. (1998) and Daniel et al. (1998) for these models.