A Research On The Construction Of Investor Sentiment Index Based On PLS And Its Application

The traditional financial theoretical models assume that the investors are rational and that the capital market is valid.The stock price could unbiasedly reflect the fundamental value of the stock on the basis of the two important prerequisites.However,according to behavioral finance,investors' decisions tend to deviate from their expectations due to the existence of heterogeneous beliefs,and investor sentiment may have an impact on the return on assets.Most scholars used to adopt the principal component analysis method to construct the investor sentiment index,while Huang et al.(2015)argue that the traditional principal component analysis method could not effectively eliminate the common noise component and they use the partial least squares method to construct new investor sentiment index.Based on the above background,the paper focuses on the reconstruction of investor sentiment index and the empirical analysis of the impact of investor sentiment index on stock returns.The main work is as follows:First,due to the big difference between China and the United States in the actual situation of the stock market,the paper selects the investor confidence index,the number of new A-share account,the market price-earnings ratio and the negotiable market value-weighted turnover rate as the investor sentiment proxy variables and uses the data that span from April 2008 to June 2015 to construct investor sentiment index,following Huang et al.(2015).Compared with the investor sentiment index constructed by the principal component analysis method,the investor sentiment index constructed by the partial least squares method can reflect the fluctuation of investor sentiment in A-share market better even though their overall trend is quite consistent.Second,taking the market premium factor,scale factor and BM ratio as the control variables,the paper examines the impact of investor sentiment index on the stock returns and finds that the investor sentiment index is another factor besides the three factors,which affects stock returns.The paper further examines the impact of the investor sentiment index on the returns of the underlying stocks for margin purchases.Investors will carry out margin purchases when the investor sentiment is high,thus the demand for the stocks increases.As a result,the stock prices rise rapidly and returns on the stocks will also increase.In conclusion,the empirical results of this paper show that the investor sentiment index constructed by the partial least squares method can explain the stock returns and that the investor sentiment has a significant positive effect on the stock returns.