A Study Of The Impact Of Emotions On Asset Pricing

The overly "rational" assumptions of traditional finance can no longer explain the various anomalies that often occur in modern financial markets.Scholars have come to realize that investors are not programmed machines and are not completely rational when making investment decisions.If such influences are not taken into account,there will be significant biases in our market forecasts,so scholars have included investor sentiment in their research.Current research on investor sentiment falls into two main categories,the first being the interpretation of sentiment within the framework of rational expectations and the other being data-based empirical studies.The former provides theoretical support for the impact of investor sentiment on the market,while the latter confirms that such an impact does exist.The theoretical study in this paper uses the Rational Expectation Equilibrium(REE)model as a benchmark framework to interpret the impact of sentiment on traders’ strategies,equilibrium prices,and market quality,and to dissect the difference between investor sentiment and market noise and describe its causes and logical mechanisms.The results show that investor sentiment motivates rational traders to derive two rational "follow-the-leader" strategies that are different from traditional strategies.Under the exogenous information access mechanism,sentiment and noise trading have opposite effects on market liquidity;increased uncertainty in noise trading reduces price information precision,but sentiment trading does not affect price information precision.Under the endogenous mechanism of information access,the impact of noise trading on price information precision and liquidity is consistent with the exogenous situation,while the "follow-the-leader" strategy of rational traders leads to a crowding-out effect of investor sentiment on information,which reduces price information precision;in the case of a more transparent overall market environment,the direct impact of sentiment on liquidity is reflected When the overall market environment is transparent,sentiment has a direct effect on liquidity,i.e.,high sentiment increases market liquidity,while when the overall environment is uncertain,sentiment has an indirect effect on liquidity,i.e.,high sentiment deteriorates liquidity.The empirical research part refers to the BW index used by Baker and Wurgler in their 2006 article,and selects consumer confidence index(CCI),discount rate of funds(DCEF),number of IPOs(IPON),trading volume in the previous month(TURN),number of new investor accounts opened in the previous month(NIA),and IPO first-day returns(IPOR)as sentiment proxies to construct sentiment index,analyze the validity of the index,and verify its impact on the Chinese stock market.The results find that:(i)the sentiment index can explain the direction of the Chinese stock market in the last two decades at a macro level.(ii)The sentiment index has a significant negative overall effect on individual stock returns,i.e.,high sentiment leads to low returns.(iii)The sentiment index has a cross-sectional effect on stock returns,with different effects under different grouping indicators.