Investors’ Uncertainty and Stock Market Risk

Escobari, Diego and Jafarinejad, Mohammad (2018): Investors’ Uncertainty and Stock Market Risk. Forthcoming in: Journal of Behavioral Finance

Abstract

We propose a novel approach to model investors' uncertainty using the conditional volatility of investors' sentiment. Working with weekly data on investor sentiment, six major U.S. stock indices, and alternative measures of uncertainty, we run various tests to validate our proposed measure. The estimates show that investors' uncertainty is greater during economic downturns, and it is linked with lower investors' sentiment. In addition, the results support the existence of a positive conditional correlation between sentiment and returns. This positive spillover between sentiment and returns is interpreted as a positive link between investors' uncertainty and market risk. We also find that investors’ uncertainty and market risk are strongly driven by their lagged values. Our measure consistently captures periods of high uncertainty as shown by a positive and highly statistically significant correlation with other existing measures of uncertainty.

• Item Type: MPRA Paper
• Language: English
• Keywords: Conditional Volatility; Dynamic Correlation; DCC-GARCH; Investors’ Uncertainty; Sentiment; Stock Market Risk
• Subjects: G - Financial Economics > G2 - Financial Institutions and Services > G20 - General; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; G - Financial Economics > G2 - Financial Institutions and Services > G23 - Non-bank Financial Institutions ; Financial Instruments ; Institutional Investors; R - Urban, Rural, Regional, Real Estate, and Transportation Economics > R3 - Real Estate Markets, Spatial Production Analysis, and Firm Location; R - Urban, Rural, Regional, Real Estate, and Transportation Economics > R3 - Real Estate Markets, Spatial Production Analysis, and Firm Location > R31 - Housing Supply and Markets

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