Sentiment dynamics and stock returns: the case of the German stock market

Thomas Lux

No 1470, Kiel Working Papers from Kiel Institute for the World Economy (IfW Kiel)

Abstract: We use weekly survey data on short-term and medium-term sentiment of German investors in order to study the causal relationship between investors' mood and subsequent stock price changes. In contrast to extant literature for other countries, a tri-variate vector autoregression for short-run sentiment, medium-run sentiment and stock index returns allows to reject exogeneity of returns. Depending on the chosen VAR specification, returns are found to either follow a feedback process caused by medium-run sentiment, or returns form a simultaneous systems together with the two sentiment measures. An out-of-sample forecasting experiment on the base of estimated VAR models shows significant exploitable linear structure for the richer VAR(5) model. Out-of-sample trading experiments underscore the potential for excess profits from a VAR-based strategy compared to the buy-and-hold benchmark.

Keywords: Investor sentiment; opinion dynamics; return predictability (search for similar items in EconPapers)
JEL-codes: C22 G12 G14 (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:ifwkwp:1470

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