Investor sentiment and market dynamics: Evidence from index futures markets

ABSTRACT

This study presents an investor sentiment proxy with a greater explanatory power in determining price changes in the Korean futures market and examines the effect of investor sentiment on futures price changes. We also consider how investor-trading behaviour affects the association between investor sentiment and futures prices. Our empirical results demonstrate that the multiple-variable method is appropriate for examining the explanatory power of investor sentiment in the KOSPI200 index futures market. Investor sentiment significantly affects futures price changes, indicating its important role in futures price dynamics. Futures market sentiment has a greater effect on futures price changes during a positive net position state period. Furthermore, we find that foreign institutional investors’ trading behaviour is positively related to changes in futures prices.

KEYWORDS:

• investor sentiment
• investor trading behaviour
• KOSPI200 futures
• sentiment index
• open interest

JEL CLASSIFICATIONS:

• G13
• G14
• G15

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1 Lucia and Pardo (2010) measure speculative (hedging) activities from volume (OI) in futures market and suggest that the ratio of OI contracts to futures trading volume reflects hedging activities.

2 Measuring investor sentiment using only a single variable has a limitation that a single proxy variable is likely to be affected by a factor (i.e., macroeconomic variable) than investor sentiment. Since investor sentiment using multiple variables extracts common factors of individual sentiment proxies, we can eliminate the possibility of changes due to factors other than investor sentiment. Also, sentiment proxy related to investor sentiment but with insufficient explanatory power to be used as a single variable can be included in the analysis, making it possible to estimate the impact of investor sentiment on the financial market accurately.

3 Underlying asset return is another factor that can affect futures price dynamics because index futures should co-move when the underlying spot index changes. However, adding the variable related to KOSPI200 index movement (i.e., KOSPI200 index return) in the regression equation to explain futures price movement incurs a high multicollinearity problem because correlation between KOSPI200 index and KOSPI200 futures prices is close to 1. So, we use the VKOSPI as control variable to capture the investor sentiment in underlying market in this study.

4 Empirical results of prior literature indicate that investor sentiment has a greater effect on the asset return during the optimistic sentiment state period (Gao & Yang, 2018; Karlsson, Loewenstein, & Seppi, 2009; Kim & Byun, 2010; Stambaugh, Yu, & Yuan, 2012; Yu & Yuan, 2011). However, our findings suggest different results in that investor sentiment in the index futures market is likely more significant for pessimistic sentiment state period when considering informed trading of investor types and macroeconomics variables, which may affect futures price change.

Additional information

Funding

This work was supported by the Ministry of Education of the Republic of Korea and the National Research Foundation of Korea (NRF- 2021S1A5A8066044). This work was supported by the Dongguk University Research Fund of 2021.