Is investor sentiment contagious? International sentiment and UK equity returns

Abstract

This paper contributes to a growing body of literature studying investor sentiment. Separate sentiment measures for UK investors and UK institutional investors are constructed from commonly cited sentiment indicators using the first principle component method. We then examine if the sentiment measures can help predict UK equity returns, distinguishing between “turbulent” and “tranquil” periods in the financial markets. We find that sentiment tends to be a more important determinant of returns in the run-up to a crisis than at other times. We also examine if US investor sentiment can help predict UK equity returns, and find that US investor sentiment is highly significant in explaining the UK equity returns.