A study on the effect of investor sentiment on returns of selected financial assets

Abstract

Traditional finance assumes rational decision-making, but behavioural finance highlights the influence of emotions and cognitive biases. Investor sentiment, defined as the collective mood of investors, has been shown to affect asset prices, yet no universal measure exists. Sentiment is assessed through both direct methods, such as surveys, and indirect proxies like the Volatility Index and Google Trends. Literature reveals inconclusive evidence on the impact of sentiment on stocks and cryptocurrencies, with limited studies focusing on Indian indices and altcoins. Most crypto research focuses on Bitcoin, overlooking the importance of altcoins and the interrelationships among sentiment factors. This study addresses these gaps by examining how investor sentiment influences the returns of cryptocurrencies and stock market indices using a mixed-methods approach. The qualitative phase identifies key sentiment factors through a systematic literature review, analysed using Total Interpretive Structural Modelling and MICMAC. Quantitatively, the study employs OLS, quantile regression, ARDL, and VAR Granger causality using daily data from January 2013 to August 2024 on the top ten cryptocurrencies, Indian indices, control variables like SandP500 and gold, and sentiment proxies such as the Google Investor Sentiment Index and VIX. The sentiment index was developed using the Trendecon package in R. Findings show that investor sentiment significantly affects both markets. In cryptocurrencies, negative sentiment impacts speculative assets like Bitcoin and Ethereum, while stablecoins show a positive relationship. Stock indices, especially Nifty Small-Cap, respond more during bearish conditions. VIX affects stock indices in both bullish and bearish markets. This research contributes to behavioural finance by offering insights for investors, analysts, and policymakers, emphasizing the value of sentiment indicators and calling for enhanced market transparency and regulation. newline