The effect of investor sentiment on stock returns in Norway and Vietnam

Abstract

This study investigates the effects of investor sentiment on stock returns in the Norwegian and Vietnamese stock markets. The model introduced by Baker and Wurgler (2006) has been utilized in which a composite sentiment index has been constructed based on six proxies. Two additional proxies for investor sentiment, VIX and CCI, have been added in order to improve the estimating power of the sentiment index. Through establishing portfolios of different types of stocks, we found that the sentiment effect on returns is stronger for stocks that are hard to value and hard to arbitrage, i.e. small, high volatility, non-dividend-paying, and value stocks. Sentiment negatively predicts these types of stocks’ returns, i.e. when sentiment is low (high), future stock returns tend to be higher (lower). Particularly in Norway, when sentiment is high, subsequent returns are relatively low for small firms and unprofitable firms. In Vietnam, when sentiment is high, subsequent returns are relatively low for small firms and firms with highly volatile stock returns. And vice-versa. The results from a robustness test of the orthogonalized sentiment indices for Norway and Vietnam shows that the sentiment indices for Norway are sensitive to VIX whereas the sentiment indices in Vietnam show no pattern. This implies that VIX plays an important role when constructing the sentiment index in a developed stock market, i.e. Norway, than in an emerging stock market, i.e. Vietnam. CCI as a sentiment proxy can also forecast stock returns in Norway, however, its predictive power is not as strong as VIX.