National Stock Exchange of India

Abstract

This study explores the relationship between investor sentiment and stock return volatility using monthly data from National Stock Exchange (NSE) of India over July 2001 to December 2013 period. Using seven market-related implicit indicators a sentiment index has been constructed with the help of principal component analysis. Then the analysis has been done by employing ordinary least squares methods, vector autoregression, Granger causality and EGARCH-M models. Findings show that sentiment index significantly influences market excess returns. At the first glance it was found that sentiment has negative influence on the conditional volatility. However, when the sentiment index is decomposed into positive sentiment and negative sentiment changes, the study reveals that positive and negative sentiments have asymmetric impacts on excess return volatility. The Granger causality results suggest a bi-directional causality between excess return and investor sentiment at the third lags.