Understanding Investor behavior and it's implications on Capital Markets - The Indian Context

Bhaduri, Saumitra and Gupta, Saurabh (2015): Understanding Investor behavior and it's implications on Capital Markets - The Indian Context.

Abstract

The paper aims to study the dynamic investor behavior and how it helps explain variation in stock returns. We propose a dynamic factor model to extract distinct latent factors representing fluctuations in asset returns due to changes in fundamentals and investor behavior. We study investor behavior under two broad categories, market-wide sentiment and herding. Our analysis suggests that both factors significantly impact the asset pricing and show varied volatilities across the sample. The model also ascertains empirical characteristics of the identified behavioral factors.

• Item Type: MPRA Paper
• Language: English
• Keywords: Sentiment, Herding, Dynamic Factor Model, Mis-pricing of Asset Returns
• Subjects: G - Financial Economics > G1 - General Financial Markets; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates

References

Agarwalla, S. K., Jacob, J., & Varma, J. R. (2013). "Four factor model in Indian equities market". Indian Institute of Management, Ahmedabad, W.P. No. 2013-09-05.

Baker, M., & Wurgler, J. (2006). "Investor Sentiment and the Cross-Section of Stock Returns". Journal of Finance, 1645-80.

Baker, M., & Wurgler, J. (2007). "Investor Sentiment in the Stock Market". NBER Working Paper Series.

Barberis, N., Andrei, S., & Robert, V. (1998). "A model of investor sentiment". Journal of Financial Economics, 307-343.

Bhaduri, S. N., & Mahapatra, S. D. (2013). "Applying an alternative test of herding behavior: A case study of the Indian stock market". Journal of Asian Economics, 43-52.

Bikhchandani, S., & S., S. (2000). "Herd Behavior in Financial Markets". IMF Working Paper WP/00/48.

Bikhchandani, S., Hirshleifer, D., & Welch, I. (1998). "Learning from the Behavior of Others: Conformity, Fads and Informational Cascades". Journal of Economic Perspectives, 151-170.

Bikhchandani, S., Hirshleifer, D., & Welch, I. (1998). "Learning from the behavior of others: Conformity, Fads, and Informational Cascades". The Journal of Economic Perspectives, 151-170.

Chang-Jin, K., & R.Nelson, C. (1999). "State Space Models with Regime Switching". Cambridge, Massachusetts: The MIT Press.

Christie, W. G., & Huang, R. D. (1995). "Following the Pied Piper: Do Individual Returns Herd around the Market?" Financial Analysts Journal, 31-37.

Devenow, A., & Welch, I. (1996). "Rational herding in financial economics". European Economic Review, 603-615.

Fama, E. F., & French, K. R. (1993). "Common risk factors in the returns on stocks and bonds". Journal of Financial Economics, 3-56.

Fama, E. F., & French, K. R. (2004). "The Capital Asset Pricing Model: Theory and Evidence". Journal of Economic Perspectives, 25-46.

Forni, M., Hallin, M., Lippi, M., & Reichlin, L. (2000). "The Generalized Dynamic-Factor Model: Identification and Estimation". The Review of Economics and Statistics, 540-555.

He, Z., Huh, S.-W., & Lee, B.-S. (2010). "Dynamic Factors and Asset Pricing". The Journal of Financial and Quantitative Analysis, 707-737.

Hwang, S., & Salmon, M. (2004). Market Stress and Herding. Center for Economic Policy Research, Discussion Paper No.4340.

Hwang, S., & Salmon, M. (2013). "Sentiment, Beta Herding, and Cross-sectional Asset Returns". Korean Finance Association.

Khorana, A., C., C. E., & W., C. J. (2004). "An Examination of Herd Behavior in Equity Markets: An International Perspective". Journal of Banking & Finance, 1651-1679.

Scharfstein, D. S., & Stein, J. C. (1990). "Herd Behavior and Investment". American Economic Review, 465-479.

Shiller, R. (1995). "Conversation, Information, and Herd Behavior". Rhetoric and Economic Behavior.

Shleifer, A., & Vishny, R. W. (1997). "The limits to Arbitrage". The Journal of Finance, 35-55.

Stock, J. H., & Watson, M. W. (2002). "Macroeconomic Forecasting using Diffusion Indexes". Journal of Business and Economic Statistics, 147-162.

Stock, J., & Watson, M. (November, 1988). "Probability model of coincident economic indicators". National Bureau of Economic Research, Working Paper No. 2772.

Tversky, A., & Daniel, K. (1974). "Judgement under Uncertainty: Heuristics and Biases". Science, 1124-113.