Predicting Stock and Bond Market Returns with Emotions: Evidence from Futures Markets

Abstract

We explore the ability of market emotions (fear, gloom, joy, optimism) to predict S&P 500 Index and 10-year Treasury notes futures returns by utilizing VAR and TGARCH models. In our VAR models, we find that one of four emotions (fear) has predictive power for stock index futures returns. We also find Treasury futures market returns are influenced by joy and optimism measures of emotions. Further, we employ a TGARCH model with anemotional sentiment measure (fear) and find that fear has a major effect on the market returns and conditional volatility of futures markets.

Keywords:

• Investor sentiment
• GARCH model
• Stock and bond return predictability
• Futures market

Notes

1 The results are not reported here but are available upon request from the authors.

2 We utilize a family of GARCH models, and using the best fit (lowest AIC), TGARCH models are selected for this study.

3 We also include volume in our model since it is considered an economic-based sentiment (Baker and Stein 2004, Tetlock (2007).