Introduction

Predictive power of sentiment may not be able to separately

identify the price change as a correction pattern for a miss
pricing or adjustment dynamic in relation to the regime
switching stock fundamentals. (San Lin Chung and Chung Ying
Yeh).
A whole new industry has emerged around the financial market
sentiment detection. In the beginning, research on stock market
prediction was based on Effiecient Market Hypothesis and
random walk theory. In EMH, new information i.e. news has a
major impact on stock prices then past stock market prices.
Since news are not predictable, the stock market will follow a
random walk pattern.
Classical theory of finance based which on the efficient market
hypothesis (EMH) assuming investors as rational risk averse
who make the market informationally efficient in which the
asset returns are unpredictable, whereas the behavioural science
theory proclaims ‘noise traders’ as irrational arbitrators- driving
the price away from the Intrinsic values or fundamentals.
Noise traders in the financial market act on noisy signals,
driving the systematic and unsystematic risk at an equilibrium
position (theoretical framework of “noise”, Black, 1986).
If investors trade on noisy signals unrelated to market
fundamentals asset prices will divert away from the intrinsic
value suggested by DSSW theory of De Long, Shleifer,
Summers, and Waldmann (1990). The DSSW theory also
explains why noise traders risk and it also states that in the long
run prices will revertto the fundamentals even if the process is
long.
Delong et al. (1990) define sentiment as the component of
expectations about the asset results that are not warranted by
Consumers confidence index is a proxy for investor sentiment.
Ho hung (2009), Schmeilng (2009), Akhtar et al. (2011),
Zouaoui et al (2011), states the proxy sentiment with consumer
confidence. To this Fisher and Statman (2002), states that
though investor sentiment and consumers sentiment or not the
same there is a significant and positive relationship amongst
them. The relationship between consumers confidence and stock
market is to find out whether there is a strong relationship
during the concerning period.
Schliefer (2003) denotes that estimation of stock price is flexible
when the investor sentiment is taken into account with limited
arbitrage fundamentals.
Stock prices on average under-react to earning surprises (post-
earnings announcement drift), and over react to operating
accruals component of earnings. Accruals and earnings related
patterns of return predictability are referred to as ‘anomalies,
‘under-‘ and ‘over-reactions’ or as reflecting investor
‘optimism’, ‘pessimism,’ or naivet’e’. these labels offer some
guidance as to whether the source of these effects. A procedure
for conjecturing a separate psychological bias for each
miscreation pattern creates a problem for model overfitting;
explanatory power is bought at the expense of predicting power.
(David Hirshleifer, Sonya S. Lim & Siew Hong Teoh, Limited
Investstor Attention)
Parsimonious explanation from both wonder in overreactions to
earnings and earning components is offered by limited attention.
The model of limited attention is consistent with post-earnings
announcement drift, the accural anomaly, the cash flow
anomaly, and the profit anomaly.
Investor sentiment, the behavioural component in asset price
volatility, is broadly defined as a belief that the future cash
flows and investments, is unjustified by the facts at hand (Baker
& Wurgler 2006, 2007). The force that drives asset prices to the
levels which are not supported by fundamentals or intrinsic
value is the impulse of investor sentiment by irrational
exuberance or unsustainable investor enthusiasm.
Investor sentiment induces anecdotal market movement,
representativeness,conservatism and intuitively affects the return
volatility through spontaneous shocks in demand shift, (Brown,
1999;Shleifer & Vushney,1997).
Investor Sentiment affects the stock price by changing the
required rate of return and the expected earning growth. For the
required rate of return, the sentiment effect during pessimistic
period is evidently different from that when the sentiment is
colrelatively high. Investor sentiment has also an asymmetric
effect on stock price and receives more importance for stocks
with high information uncertanities whereas accounting
information is reliable for stocks with stable earnings.
The effects of different state of sentiments- positive and
negative changes, on market access returnes are examined by
augmenting the central sentiment change in the conditional
volatility model similar with Lee et al (2002), Qiang and Shu-e
(2009), and Chuang et al. (2010) and Perez-Liston et al. (2014).
Bennet et al.(2012), Dash and Mahakud (2012, 2013a, 2013b),
and Chandra and Thenmozhi (2013) used Indian data to
examine the impact of investor sentiment, primararily dealing
with one part of the analysis being the overall impact of investor
sentiment on stock returns and the role of different states of
investor sentiment, if any, in generating market volatility was
neglected.
The investigation in the context of emerging market economy
by providing more ideas about the market behaviour and how a
set of investors i.e. the noise traders with the different states of
investor,sentiment affect market access return. This would
enable us to know that the biases in stock market forecast of
investors and it also teaches us about the opportunities to earn
extra returns by exploiting those biases, (Fisher and
Statman,2000).
The various empirical findings of studies conducted our:
a. The effect of sentiments on predicting the cross-section of
future stock returns are conditional on the state of regime
i.e. magnitude of coefficient estimates associated with
sentiment increases while the regiments are controlled.
b. After the conditioning on sentiment and regimes dividend
and earning oriented portfolios perform strong conditional
predictability patterns.
c. Value affects and size of the appearance are also
conditional on sentiment and state of the regime.
d. The cross-section predictability patterns associated with
sentiment reflect the mis-pricing, not the compensation
for systematic risk.
Many researchers are of agreement that investor senitment
are economically significant: as the concept is still very
cryptic and abstract. Inavestor Sentiment can be said as the
belief about the furture cash flows and investment risks
which are unjustifiable by the present facts.
As per the traditional finance theory, accounting information
reflects the profitability as well as the quality of the assets,
which can be used to forecast equity prices. The investors, if
irrational, their psychological factors or cognitive bias could
affect their investment decisions. The stock price variation
not only relies on the intrinsic value represented by the
accounting information but also on the investors irrational
behaviours, measured by investor sentiment. Investor
sentiment derived from incorrect subjective beliefs or
unrelated information that asset value, may lead to falls
market anticipation and fuel market volatility.
Chen (2011) developed a framework to explain the sentiment
effects and found that investor sentiment can affect the value
relevance of accounting information. Sentiment could affect
the predicted earnings growth as investors usually have an
optimistic attitude towards the future during the high
sentiment period whereas stock analysts tend to issue higher
ratings for those hard -to -value stocks.(Corner et al.,2014).
Individuals decide the level of attention by balancing out
the cost of attention against the expected benefits. In
equilibrium some investors may decide not to attend to the
implications of public information about earnings or its
components explaining the phenomenon: Why inattentive
investors who trade based upon their inattentive
expectations rather than simply remaining on the sidelines
can survive in the long run. (Hershleifer, Sonya S.S. ,
S.H.Teoh)
There are three types of investors:
a. that ignore all current earnings related information
b. attend only a subset of that information
c. attend all of that information that is publicly available.
All investors being ex-ante identical and differences in how
much of the public information set they process depends
upon the cost they have to incur to obtain information.
Assuming that in an attentive investors apart from the
specific signals that ignore update believe as rational
Bayesians.
There are 2 dates:
At date 1, cash flow C1, accurals a1, and earnings E1= c1+a1
are realised.
Investors update their prior beliefs based upon whatever
public signals they observe.
At date 2, terminal earnings, cash flow, and accruals, e2,c2
and a2, are realised ,where e2= c2+a2, and the firm is
liquidated.
 In general, accounting accrual must reverse out, so we
assume that a2=-a1 (Sonya, David Hirsheifer, and S.H.Teoh).

Literature Review
Otto (1999) was the 1st to examine the relationship between
equity prices and consumers confidence by using the monthly
data of Wilshire 5000 stock index from June 1980 to June 1999.
The Granger causality test of Otto indicates that stock price
consumers confidence is affected bt the movements in the stock
price but the lagged changes in confidence have no explanatory
power for stock prices.
In 1961, Graham (1973), Malkiel (1990) and Brown (1991), was
characterised by a high demand for small, young growth stocks,
where Malkiel writes of a “new-issue mania” that was
concentrated on new “tronics” firms. “… The Tronics boom
came back to earth in 1962. The tail spin started early in the year
and exploded in the horrendous selling wave… Growth stocks
took the brunt of the decline, falling much further than the
general market” (p.54-57)
The stock returns and consumers confidence are correlated in
countries where stock ownership is high such as UK and also
the stock returns impact consumers confidence at very short
horizons for two weeks or one month, (Jansen and Nahuis,
2003). Brown and Cliff extend the study of Otto (1999) and
Jansen and Nahuis(2003), indiacting indicating a perfect
positive relationship between consumers sentiment and market
returns.
The VAR analysis carried out by them reveals that market
returns predict future sentiment and sentiment predicts market
returns, but with little evidence. They also grouped the investor
sentiments: as
1. Individual Sentiment affecting samll stocks and
2. Institutional investor sentiment affecting large stocks.
Bremmer (2008) examine the the relationship between the
consumers confidence and the most common stock indices such
as Dow Jones, S&P 500 and NASDAQ and also apply co-
integration test to measure the long-run relationship. He states
that the expected changes in consumers confidence have no
impact on stock prices whereas unexpected changes are related
to changes in stock prices.
Spyrou (2012) after examining the relationship between the
monthly returns of US stock portfolio formed on book-to-market
equity (B/M), long-term reversals, momentum and size for a
period ranging 1965-2007 finds that’s contemporaneous returns
are significantly related to monthly sentiment changes and tend
to be on the higher side during periods of negative sentiment.
He also states that the stock returns are more important in
predicting sentiment changes and vice versa and that the
conditional return volatility is significantly affected by lagged
volatility rather than the sentiment changes.
Among few studies that argue that consumers confidence predict
stock returns is Fisher and Statman (2003) who examine the
relationship between consumers confidence measured by the
Michigan’s CCI and Conference Board CCI and S&P 500,
NASDAQ and small cap stock returns,indicating that consumers
confidence predicts the stock returns and they also find a
positive relationship for high stock returns indicating that the
high returns boost the consumer confidence.
Baker and wurgler (2007) finds that the both global and local
sentiment predicts the market returns as well as the relative
returns for the small highly volatile distressed and growth
portfolios for major stock markets.
Scmeling (2009), states that sentiment negatively forecast
expected returns on average across countries, which holds for
returns of value stocks, growth stocks, small stocks and for
different forecasting horizons. They also find that the impact of
sentiments on returns is stronger for countries which have less
developed market institutions and for countries that are
culturally more prone to investor overreaction.
Chen (2011) is the first study which examines the asymmetric
effects of negative sentiment during market fluctuations. He
uses monthly returns of S&P 500 Price Index by using Markov-
Regime switching model and results support the asymmetric
effect which reveals the impact that is greater in bear market. He
also finds that greater the market pessimism the higher is the
probability of switching from a bull to a bear market.
Most prior studies documented that investor sentiment would
affect price combined with accounting information and also
indicate the heterogeneity of the sentiment effect. Whereas the
existing literature rarely provides the basis for the mechanism
behind the effect of sentiment and accounting information and
also which explains the cross-section difference of this
mechanism.
The above stated anecdotes suggest some regular patterns in the
effect of investor sentiment on the cross-section. Canonical
extreme growth stocks seem to be specially prone to bubbles
and subsequent crashes, consistent with observation that they
are more appealing to speculators and optimists and at the same
time hard to arbitrage.
A notable exception to this, was the “nifty fifty” bubble, but the
anecdotal accounts suggest that this bubble occurred during a
period of broadly low sentiment, so that it may be still consistent
with the cross-sectional prediction that an increase in sentiment
increases the relative price of those stocks that are the most
subjective to value and the hardest to arbitrage.
The persistence of the relationship between sentiment index and
the volatility of the stock markets suggest that investor
sentiment in India plays a significant role in determining the
stock market volatility (Journal of Asia Pacific Business,pg177).
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