Investor Sentiment And The Volatility Leverage Effect

The volatility leverage effect is a stylized fact which says negative return shock has a stronger effect on volatility than positive one.Classical theories have limited power in explaining this phenomenon and also cannot explain the anti-leverage effect.As an indicator of investors’cognitive bias and irrational strategies,investor sentiment has a systematic effect on stock pricing and the market volatility.By testing the impact of investor sentiment on the volatility leverage effect,this thesis enriches the literature related to volatility leverage effect,portfolio optimization,risk management,option pricing and market supervision.First of all,we use the principal analysis method to construct an investor sentiment index with 5 proxies including closed-end fund discount rate,dividend premium,market turnover,consumer confidence index and the number of newly-added stock accounts.Then we use wavelet analysis method to decompose investor sentiment index and define the short-term sentiment and the long-term sentiment.We use five-minute returns of Shanghai Composite Index from Mar.3^rd in 2003 to Mar.31^st in 2017 to construct daily realized volatility.And then test how investor sentiment index,the short-run sentiment and the long-run sentiment affect the volatility leverage effect.The regression results show that the effect of investor sentiment on the volatility leverage effect depends on the relative portion of the short-run sentiment and the long-run sentiment.The short-run sentiment weakens the volatility leverage effect while the long-run sentiment strengthens the volatility leverage effect.In the section of robustness test,we firstly incorporate IPO-related variables to construct a new sentiment index,then compare the results of Shenzhen Composite Index and the Growth Enterprise Market Index,and then add macro-economic variables into the leverage effect regression model,finally we replace the realized volatility with three Garch-type volatility.Our results are robust in all of these cases.Meanwhile,we find the effect of short-run or long-run sentiment on the leverage effect depends on the market cap of the indexes.Plus,we find the effect of investor sentiment mainly comes from its effect on transitory volatility.