Does investors’ sentiment predict stock price changes? With analyses of naive extrapolation and the salience hypothesis in Japan

Abstract

This paper investigates the forecast power and the characteristics of investors’ sentiment in Japan. According to the empirical analyses, Japanese investors’ sentiment has some forecast power for one month's future equity market dynamics. In addition, evidence is found that simultaneous and synthetic use of several sentiment variables is helpful for predicting future stock price changes in the short-term forecasting period. However, in contrast to findings in the USA, evidence cannot be found for ‘naive extrapolation’ or the ‘salience effect’ in Japanese investors’ sentiment.

Acknowledgements

We wish to thank the Japan Society for the Promotion of Science and the Zengin Foundation for Studies on Economics and Finance for their generous financial assistance on this research.

Notes

¹ Other related studies that consider this sentiment in the USA are Andreassen (1987; 1988); Billingsley and Chance (1988); De Long et al. (1990a; 1990b); Lee et al. (1991); De Bondt (1993); Klibanoff et al. (1998).

² Simpson and Ramchander (2002) investigated whether the differential sentiment is a cause of closed-end country fund premia in the Australian market. Wang (2003) examined whether an actual trader position-based sentiment index is useful for predicting returns in the S&P 500 index futures market. Chelley-Steeley and Siganos (2004) tested whether macroeconomic variables and market sentiment influence the size of momentum profit in the UK stock market. Skiadopoulos (2004) investigated an implied volatility index as a measure of investors' sentiment in the Greek option market.