Investor Sentiment Dynamics and Stock Returns: Evidence from Indian Market

This research explores the connection between market-wide investor sentiment and stock market return within the framework of the Indian stock market.The study investigates how investor sentiment affects stock market returns, specifically examining the Nifty50 indices in the Indian stock market between April 2013 and March 2023.By employing PCA, we developed a sentiment index (SENT) for investors using five proxy market variables for sentiment.We used the VAR model, VAR Granger causality tests, impulse response, and Variance decomposition analysis to investigate how the sentiment index relates to market returns.The findings indicate that the Sentiment Index Granger-causes stock returns, highlighting its predictive value.Short-term shocks to the Sentiment Index significantly impact stock returns, while the effect of stock returns on sentiment is minimal and only temporary.Furthermore, the results show that stock returns are primarily influenced by their past values, but over time, the Sentiment Index increasingly influences variations in stock returns.This supports a moderate positive relationship between investor sentiment and market behavior.The findings contribute to a deeper understanding of behavioral finance in emerging markets and offer valuable insights for investors, policymakers, and finance professionals.