China's Investor Sentiment And Stock Market Returns

The traditional finance theory assumes that people are rational.Investors' behavior would not affect asset pricing.The stock price is determined entirely by market fundamentals in the condition of effective market conditions.However,with the development of capital market,financial vision emerge in endlessly,such as the America's subprime crisis in 2008,the economies of scale,equity premium puzzle,the traditional finance theory does not provide a reasonable explanation.In this context,the emergence and development of behavioral finance provides a theoretical basis for explaining these financial phenomena.Behavioral finance theory is a discipline branch of behavioral economics,focuses on analyzing the behavioral biases of investors in the process of trading caused by the irrational perspective of investors.So it provide a new perspective to understand financial markets.As the history of China's stock market is short,investors show a higher degree of irrationality in the stock market trading.Investor sentiment is the result of investor psychology,that reflects investors' expectations about future market and investors' feedback about historical events and basic stock factors.The investor sentiment is an important indicator of investor behavior research.Studying investor sentiment would help us understand the motivations of investors' behavioural biases and the biases' influence on markets.It also would help investors to understand how markets work and the realistic characteristics of asset prices,so the investor could cultivate rational investment philosophy.At the same time,it is helpful for the market supervision department to improve the effectiveness of the regulatory system and perfect system current construction,so it would promote the stable development of the market.This paper views the relationship between investor sentiment and the stock market returns as the research object,and divide investor sentiment into institutional investor sentiment and individual investor sentiment in order to understand the connection between the investor sentiment and the stock market returns deeply.Based on conclusion from the domestic and foreign investor sentiment research,combined with the characteristics of China's stock market,using Principal Component Analysis(PCA)to build institutional investor sentiment index and individual investor sentiment index respectively.This paper examines the interaction between institutional investor sentiment and individual investor sentiment,then using regression analysis inspect the relationship between the institutional investor sentiment and individual investor sentiment with the stock market returns.Finally,this paper established the vector autoregressive model(VAR)of institutional(personal)investor sentiment to examine the interaction mechanism between investor sentiment and market return.The result shows that institutional investor sentiment and individual investor sentiment is influenced by each other,and institutional investor sentiment affects individual investor sentiment primarily.Whether it is institutional investor sentiment or individual investor sentiment,it would find a positive correlation between the index change and the market return.The market sentiment has a lag effect on the market earnings.Institutional investor sentiment and individual investor sentiment are not Grange reasons of stock market returns but a result.The volatility of stock market returns can affect investor sentiment,and the effect on the individual investor sentiment are more significant.In the short term,stock market returns would not significantly affected by investor sentiment,but individual investor sentiment has a higher impact on market earnings than institutional investor sentiment.