Investors’ Uncertainty and Stock Market Risk

Diego Escobari and Mohammad Jafarinejad

MPRA Paper from University Library of Munich, Germany

Abstract: We propose a novel approach to model investors' uncertainty using the conditional volatility of investors' sentiment. Working with weekly data on investor sentiment, six major U.S. stock indices, and alternative measures of uncertainty, we run various tests to validate our proposed measure. The estimates show that investors' uncertainty is greater during economic downturns, and it is linked with lower investors' sentiment. In addition, the results support the existence of a positive conditional correlation between sentiment and returns. This positive spillover between sentiment and returns is interpreted as a positive link between investors' uncertainty and market risk. We also find that investors’ uncertainty and market risk are strongly driven by their lagged values. Our measure consistently captures periods of high uncertainty as shown by a positive and highly statistically significant correlation with other existing measures of uncertainty.

Keywords: Conditional Volatility; Dynamic Correlation; DCC-GARCH; Investors’ Uncertainty; Sentiment; Stock Market Risk (search for similar items in EconPapers)
JEL-codes: G20 G21 G23 R3 R31 (search for similar items in EconPapers)
Date: 2018-05
New Economics Papers: this item is included in nep-fmk and nep-rmg
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Related works:
Journal Article: Investors’ Uncertainty and Stock Market Risk (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:86975

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