The Impacts of Investor Sentiment on Liquidity and its Volatility: Evidence from Tehran Stock Exchange

Document Type : Research Paper

Authors

1 Assistant Prof., Department of Financial Management and Financial Engineering, Faculty of Financial Science, Kharazmi University, Tehran, Iran.

2 M.Sc., Department of Financial Management, Faculty of Financial Sciences, Kharazmi University, Tehran, Iran.

Abstract

Objective: Behavioral finance and market microstructure studies showed that investor sentiment has a positive and meaningful effect on liquidity. The purpose of this study is to investigate the effect of the Aggregate Sentiment Index (ASI) on liquidity and its volatilities and to examine the symmetry of news (shocks) on the Tehran Stock Exchange (TSE).
Methods: The available academic literature on liquidity proposes a wide set of indices and proxies to measure the different characteristics and dimensions of liquidity. In this study, four indices were employed to measure the various dimensions of liquidity including Transaction Cost, Volume-Based Measure (Trading Volume), and price-impact characteristics. Accordingly, the indices of turnover and trading volume were related to the transaction costs dimension, the Amihud illiquidity ratio was related to Volume-Based Measure (Trading Volume), and the High-Low Spread index was related to the price impact characteristic. Irrational Aggregate Sentiment Index (ASI) was formed using nine indirect (institutional) indices for measuring investor sentiment using Principal Component Analysis (PCA) and the GARCH model was used to investigate asymmetry. The E-GARCH and T-GARCH models were also employed to investigate the asymmetry of news (shocks).
Results: The achieved results proved no significant relation between Turnover and Trading Volume indices but the strong impact of Amihud illiquidity ratio on investor sentiment. The findings also indicated the effects of shocks as asymmetric, i.e., optimistic (positive) shocks have greater effects than pessimistic (negative) shocks. Positive shocks cause a decrease in volatilities and an increase in liquidity.
Conclusion: Since Amihud’s illiquidity ratio is mostly affected by investor sentiment, policymakers can increase liquidity and decrease price volatility by controlling investor sentiment.

Keywords


Acharya, V. V. & Pedersen, L. H. (2005). Asset pricing with liquidity risk. Journal of financial Economics, 77(2), 375-410.
Asgari, E., Abbasian Fereidono, M.,Nasl Smosavi, H. (2020). The Impact of Investor sentiment on Stock Market Liquidity. Accounting Advances Journal, 78(12), 1-27. (in Persian)
Amihud, Y. (2002). Illiquidity and stock returns: cross-section and time-series effects. Journal of financial markets, 5(1), 31-56.
Baker, M. & Stein, J. C. (2004). Market liquidity as a sentiment indicator. Journal of Financial Markets, 7(3), 271-299.
Baker, M. & Wurgler, J. (2000). The equity share in new issues and aggregate stock returns. the Journal of Finance, 55(5), 2219-2257.
Barberis, N., Thaler, R. (2003). A survey of behavioral finance. In: Constantinides, H.M., Stulz,
Bekaert, G., Harvey, C. R. & Lundblad, C. (2007). Liquidity and expected returns: Lessons from emerging markets. The review of financial studies, 20(6), 1783-1831.
Brennan, M. J., Chordia, T. & Subrahmanyam, A. (1998). Alternative factor specifications, security characteristics, and the cross-section of expected stock returns. Journal of financial Economics, 49(3), 345-373.
Brockman, P. & Unlu, E. (2009). Dividend policy, creditor rights, and the agency costs of debt. Journal of Financial Economics, 92(2), 276-299.
Chordia, T., Roll, R. & Subrahmanyam, A. (2008). Liquidity and market efficiency. Journal of Financial Economics, 87(2), 249-268.
Cumming, G. S. (2011). Spatial resilience in social-ecological systems. Springer Science & Business Media
Datar, V. T., Naik, N. Y. & Radcliffe, R. (1998). Liquidity and stock returns: An alternative test. Journal of Financial Markets, 1(2), 203-219.
Damoori, D., Khoshnud, H. (2019). The Study of the Impact of Price Limits and Trading Halts on Trading Activities, Liquidity and Price Volatility in the Tehran Stock Exchange. Financial Research Journal, 21(2). 213-236. (in Persian)
Debata, B., Dash, S. R. & Mahakud, J. (2018). Investor sentiment and emerging stock market liquidity. Finance Research Letters, 26, 15-31.
De Long, J. B., Shleifer, A., Summers, L. H. & Waldmann, R. J. (1990). Positive feedback investment strategies and destabilizing rational speculation. the Journal of Finance, 45(2), 379-395.
Delgard, M. L., Deflandre, B., Pastor, L., Metzger, É., Gaillard, A., Grémare, A. & Anschutz, P. (2009). Use of voltametric solid-state microelectrode for studying the effect of tidal forcing on biogeochemical processes on mudflat of the arcachon bay (France).
Farajollahi, B. (2018). Investigating the Impact of Investors Sentiment on Liquidity in Iran Capital Market. M.Sc., Ershad Higher Education Institute, Damavand. (in Persian)
Gervais, S. & Odean, T. (2001). Learning to be overconfident. The Review of Financial Studies, 14(1), 1-27.
Gholami Niyachahi, F. (2018). Investigating the Impact of Investors Sentiment on Liquidity and Expected Return Rates (Case Study: Accepted Companies in Tehran Stock Exchange). M.Sc., Islamic Azad University, Shayriar. (in Persian)
Griffin, J. M., Nardari, F. & Stulz, R. M. (2007). Do investors trade more when stocks have performed well? Evidence from 46 countries. The Review of Financial Studies, 20(3), 905-951.
Hu, S., Zhong, M. & Cai, Y. (2019). Impact of Investor Behavior and Stock Market Liquidity: Evidence from China. Entropy, 21(11), 1111.
Huberman, G. & Halka, D. (2001). Systematic liquidity. Journal of Financial Research, 24(2), 161-178.
Kahneman, D. & Riepe, M. W. (1998). Aspects of investor psychology. Journal of portfolio management, 24(4), 52.
Karolyi, G. A., Lee, K. H. & Van Dijk, M. A. (2012). Understanding commonality in liquidity around the world. Journal of Financial Economics, 105(1), 82-112.
Khajavi, S., Jahandoust Marghoub, M. & Weysihesar, S. (2021). Investigating the Relationship between CEO Power and Capital Structure. Financial Research Journal, 23(1). 40-63.
(in Persian)
Kumari, J. (2019). Investor sentiment and stock market liquidity: Evidence from an emerging economy. Journal of Behavioral and Experimental Finance, 23, 166-180.
Kyle, A. S. (1985). Continuous auctions and insider trading. Econometrica. Journal of the Econometric Society, 1315-1335.
Lee, K. H. (2011). The world price of liquidity risk. Journal of stambaugh, 99(1), 136-161.
Liu, S. (2015). Investor sentiment and stock market liquidity. Journal of Behavioral Finance, 16(1), 51-67.
Longstaff, F. A., Mithal, S. & Neis, E. (2005). Corporate yield spreads: Default risk or liquidity? New evidence from the credit default swap market. The journal of finance, 60(5), 2213-2253.
Moshirian, F., Qian, X., Wee, C. K. G. & Zhang, B. (2017). The determinants and pricing of liquidity commonality around the world. Journal of Financial Markets, 33, 22-41.
Moshtaghi, Y. & Yazdani, N. (2017). Studying the influence of psychological factors with orientation perceptual errors on Decision making process of individual investors. Financial Research Journal, 18(4). 735-752. (in Persian)
Osooliam, M., Hasannejad, M., Sadeghi Sharif, J. & Hamzenejadi, Y. (2021). Intuitive Thinking, Behavioral Biases and Performance of Professional Investors in Tehran Stock Exchange. Financial Research Journal, 23(1). 17-39. (in Persian)
Pástor, L. & Stambaugh, R. F. (2003). Liquidity risk and expected stock returns. Journal of Political economy, 111(3), 642-685.
Sadi, R., Gholipour, A., Gholipour, F. (2010). The effects of investor personality and perceptual bias in Tehran stock exchange. Financial Research Journal, 12(29). 41-58. (in Persian)
Stateman, M., Thorley, S. & Vorkink, K. (2006). Investor overconfidence and trading volume. The Review of Financial Studies, 19(4), 1531-1565.
Talebi, M., Agababaei, M.E., Saeidi Kousha, M. (2020).Tehran Stock Exchange Underreaction Following Extreme Market Events. Financial Research Journal, 22(4). 521-541.
(in Persian)
Wurgler, J. (2000). Financial markets and the allocation of capital. Journal of financial economics, 58(1-2), 187-214.
Xie, T., Xu, Y. & Zhang, X. (2015). A new method of measuring herding in stock market and its empirical results in Chinese A-share market. International Review of Economics & Finance, 37, 324-339.
Xu, F. R., Zhao, E. G., Wyss, R. & Walker, P. M. (2004). Enhanced stability of superheavy nuclei due to high-spin isomerism. Physical review letters, 92(25), 252501.
Zarowin, P. (1990). Size, Seasonality, and Stock Market Overreaction, Journal of Financial and Quantitative Analysis, 25(1), 113-125.
Zhu, A., Ash, M. & Pollin, R. (2004). Stock market liquidity and economic growth: A critical appraisal of the Levine/Zervos model. International Review of Applied Economics, 18(1), 63-71.