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Applied Financial Economics Volume 18, 2008 - Issue 16
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Original Articles

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

Rahul Verma College of Business, University of Houston-Downtown, Houston, TX 77002, USACorrespondence[email protected]
,
Hasan Baklaci Department of International Trade and Finance, Izmir University of Economics, Izmir, Turkey
&
Gökçe Soydemir College of Business Administration, University of Texas-Pan American, Edinburg, TX 78541, USA
Pages 1303-1317 | Published online: 29 Jul 2008
 
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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.

Notes

1 The results of the VAR estimates are available in the technical Appendix A.

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