Investor Sentiment with Information Shock in the Stock Market

ABSTRACT

In this article, we develop an asset pricing model with investor sentiment and public information, in which there is a shock of public information on investor sentiment. We find that public information has a significant effect on asset price, and the impact of investor sentiment on asset price depends on the proportion of sentiment investors and the public information shock on investor sentiment; furthermore, the shock of public information on investor sentiment can significantly impact the asset price, price stability, and public information efficiency; more importantly, if there are sentiment investors in the market, there cannot be a market equilibrium in which price can fully reflect the public information. Our results highlight the combined effect of investor sentiment and public information on the asset price, the mechanism of public information shock on investor sentiment, and how the shock impacts the asset pricing.

KEY WORDS:

• Asset pricing
• information inefficiency
• investor sentiment
• public information

JEL:

• G12
• G14

Disclosure Statement

No potential conflict of interest was reported by the authors.

Notes

1. Public information 1: On the evening of May 29, 2007, the Ministry of Finance of China announced that the stamp duty would be increased up to 3‰ from May 30, 2007. Public information 2: On January 15, 2008, Citigroup announced a quarterly loss of more than $9 billion. Public information 3: On September 14, 2008, Lehman Brothers Failed. Public information 4: On November 11, 2008, the Chinese government announced a $4 trillion investment plan. Public information 5: On October 12, 2009, the Ministry of Finance of China promulgated the regulations on financial management of financial holding companies. Public information 6: On January 07, 2012, China concluded National Financial Work Conference.

2. We use the first principle component by Baker and Wurgler (2006) to form a composite investor sentiment index that is based on the common variation in four underlying proxies for sentiment: relative strength index (RSI), psychological line index (PSY), bull and bear Index (BBI), and adjusted turnover rate (ATR). We use Shanghai Composite Index (SHCOMP) as our proxy for the market portfolio.

Additional information

Funding

This work was supported by the National Natural Science Foundation of China: [Grant Numbers: 71471067 and 71720107002].