The-impact-of-individual-and-institutional-investo

Pleasecitethisarticleinpressas:Verma,R.,&Soydemir,G.Theimpactofindividualandinstitutionalinvestorsentimentonthemarketpriceofrisk.QuarterlyReviewofEconomicsandFinance(2009),doi:10.1016/j.qref.2008.11.001ARTICLEINPRESSGModelQUAECO-521;No.ofPages17TheQuarterlyReviewofEconomicsandFinancexxx(2009)xxx–xxxContentslistsavailableatScienceDirectTheQuarterlyReviewofEconomicsandFinancejournalhomepage:ökc¸eSoydemirb,∗aCollegeofBusiness,UniversityofHouston-Downtown,320NorthMainStreet,Houston,TX77002,UnitedStatesbCollegeofBusinessAdministration,UniversityofTexas-PanAmerican,Edinburg,1201WestUniversityDrive,78539,UnitedStatesarticleinfoArticlehistory:Received19September2007Receivedinrevisedform31October2008Accepted17November2008AvailableonlinexxxJELclassification:G12,G14,C3Keywords:StockreturnsInvestorsentimentVARmodelabstractWeexaminetheeffectofindividualandinstitutionalinvestorsen-timentonthemarketpriceofriskderivedfromDJIAandS&P500indexreturns.Consistentwithbehavioralassetpricingmodels,wefindsignificantpositiveresponseofrationalsentimentsuggestinggreaterincentiveforrationalinvestorstoengageinarbitragewhenthecompensationfortakingriskisgreater.Further,anincreaseinirrationaloptimismleadstoasignificantdownwardmovement,butanincreaseinrationalsentimentdoesnotleadtoasignificantchangemarketpriceofrisk.Theseresultsarerobustforbothmarketindexes,DJIAandS&P500andforbothindividualandinstitutionalinvestorsentiment.©2008TheBoardofTrusteesoftheUniversityofIllinois.PublishedbyElsevierB.V.Allrightsreserved.1.IntroductionIrrationalinvestorsentimentplayslittleroleinthestandardrisk-basedassetpricingliterature.Theissueofinvestors’irrationalityisignoredduetothecentralroleofrationalarbitrageurswhotradeagainstnoisetradersandbringstockpriceclosetoitsfundamentalvalue.However,numerousrecentstudieshavecounteredthisargumentandsuggestedthatarbitrageislimitedandthatstockpricescandeviatefromthefundamentalvalueduetounpredictabilityinirrationalsentiment.ThetheoreticalframeworkdescribingtheroleofsentimentinassetpricingisprovidedbyresearcherssuchasBlack(1986),Trueman(1988),DeLong,Shleifer,SummersandWaldman(DSSW)(1990,1991),Shleiferand∗Correspondingauthor.Tel.:[phone].E-mailaddresses:[e-mail](R.Verma),[e-mail](G.Soydemir).1Tel:[phone]-9769/$–seefrontmatter©2008TheBoardofTrusteesoftheUniversityofIllinois.PublishedbyElsevierB.V.Allrightsreserved.doi:10.1016/j.qref.2008.11.001Pleasecitethisarticleinpressas:Verma,R.,&Soydemir,G.Theimpactofindividualandinstitutionalinvestorsentimentonthemarketpriceofrisk.QuarterlyReviewofEconomicsandFinance(2009),doi:10.1016/j.qref.2008.11.001ARTICLEINPRESSGModelQUAECO-521;No.ofPages172R.Verma,G.Soydemir/TheQuarterlyReviewofEconomicsandFinancexxx(2009)xxx–xxxSummers(1990),Lakonishoketal.(1991),CampbellandKyle(1993),ShefrinandStatman(1994),Palomino(1996),Barberisetal.(1998),Danieletal.(1998)andHongandStein(1999).Recentbehavioralassetpricingmodelspredictlinkagesbetweenirrationalsentimentandthemar-ketpriceofrisk(MPR)(Abel,2002;Basak,2005;Cecchettietal.,2000;Garrettetal.,2005;Girardetal.,2003;Jouini&Napp,2005;Li&Zhong,2005;Yu&Yuan,2005).Overall,thesetheoreticalstudiessuggestthatirrationalinvestorsandrationalarbitrageursholdoppositebeliefs,i.e.,whennoisetradersarepessimistic,rationalarbitrageursareoptimistic.Insuchscenario,thecompensationforbearingriskshouldbehighertoattractmorewealthfromrationalarbitrageurs,thusadjustingMPRupwards.Conversely,whenirrationalinvestorsareoptimistic,MPRshouldbelowertodeterrationalinvestorsfrommakinginvestments.Despitethewell-documentedliteratureontheimportanceofinvestor’sirrationalityasapossibledeterminantoffluctuationsinMPR,fewempiricaltestshavebeenundertakentoinvestigatesuchrela-tionships.Inthisstudy,weusemonthlydataofinvestorsentimentattheindividualandinstitutionallevelprovidedbytheAmericanAssociationofIndividualInvestorsandInvestorsIntelligencetoempiricallytestthesetheoreticalpropositions.Specifically,wefocusonbothrationalandirrationalcomponentsofinvestorsentimentandinvestigatetheirrelationshipwithMPRderivedfromtheDJIAandS&P500returns.Wemakethefollowingcontributionstotheexistingliterature.First,unlikethepreviousstudieswhichtreatsentimentasfullyirrational,wefocusonbothrationalandirrationalcomponentsofinvestorsentimentandexplorehowfundamentalandnoisetradingmayaffectMPR.Second,unlikepreviousstudies,whichtreatthetwoclassesofinvestorsentimentinisolation,weinvestigatetheeffectsoftheindividualandinstitutionalinvestorsentimentonMPR,jointlyinonemultivariatemodeltoexaminethedynamicsbetweenthetwotypesofsentiment.Shocksoriginatingfromsentimentofoneclassofinvestorsnotconsideredmightmistakenlybeperceivedasadisturbanceoriginatingfromaclassofsentimentconsideredintheanalysis.Third,unlikepreviousstudies,whichcaptureonlytheanticipatedchangesinsentiment,weexaminetheunanticipatedcomponentofsentimentonMPRinlinewithrationalexpectationstheory.Theresultsofthegeneralizedimpulsesgenerate