Title: Sentiment and stock returns: aggregate and cross-sectional analysis from Pakistan

Authors: Sana Tauseef; Hira Suman

Addresses: Department of Finance, Institute of Business Administration (IBA), Karachi, Pakistan ' Social Investment Managers and Advisors (SIMA Funds), Karachi, Pakistan

Abstract: This study examines the impact of investor sentiment on aggregate stock market returns and on cross-section of stock returns for the emerging market of Pakistan. We constructed an investor sentiment index using principal component analysis based on seven proxies: advances-to-decline ratio, share turnover rate, money flow index, relative strength index, price-to-earnings ratio, dividend premium and interest rate. Results of vector auto-regression suggest that one-month lagged sentiment index is a strong predictor of itself and aggregate stock market return with a positive sign, showing persistence and providing evidence of herd behaviour. Our two-dimensional sorts of stock returns indicate disproportionate effect of sentiment on the stock returns as suggested in literature on developed markets; however, the time series regressions of arbitrage portfolios fail to confirm the significance of these cross-sectional patterns.

Keywords: investor sentiment; stock returns; arbitrage portfolios; emerging market; Pakistan.

DOI: 10.1504/AAJFA.2023.132961

Afro-Asian Journal of Finance and Accounting, 2023 Vol.13 No.4, pp.502 - 527

Received: 05 Jun 2020
Accepted: 22 Jan 2021
Published online: 22 Aug 2023 *

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