Investor sentiment is believed to play an increasingly significant role in business and economic activities. By analyzing data collected from a sample of listed nonfinancial firms in Pakistan for the period 2009–2018, we quantify investor behavior and how it affects market returns, cash flows, discount rates, and firm performance. We find that investor sentiment has a significant impact on market activities, and our findings are in line with existing behavioral finance theories. Not only does our study offer theoretical confirmation of the significance of investor sentiment in aggregate market- and firm-level indicators, but it also offers new insights concerning market-based, news-based, and social media–based sentiment in the context of the Pakistani market.
Why does investor sentiment matter? For more than two decades, this question has made the rounds of finance literature. Investor sentiment has not only been a heavily covered topic in finance literature (Park & Sohn, 2013) but also explains the financial decision-making process (Parveen et al., 2020), investor positions (Frazzini & Lamont, 2008), the sources of risk (Cagli et al., 2020), risk preferences (Qadan et al., 2019), and risk premiums (Qadan & Aharon, 2019).
Investor sentiment is inevitably considered because it surfaces existing stock market biases and opens up opportunities for earning abnormal returns by taking advantage of market bias (Fisher & Statman, 2013). Previous studies have documented the relationship between investor sentiment and the stock market (Schmeling, 2009). However, identifying and measuring investor sentiment and its impact on stock returns remains an area of interest regarding emerging economies. Different methods of measuring investor sentiment have been suggested, including market-based, survey-based, and newsbased methods, as explored by Qadan and Aharon (2019). Petit et al. (2019) use a broad set of indirect and hidden information to examine investor sentiment whereas Baker and Wurgler (2006) use information on the real estate market to determine investor sentiment.
In this study, we examine the impact of market-, news- and social mediaebased investor sentiment on market activities. We analyze the effect of investor sentiment on aggregate-, market-, and individual firmelevel indicators using the principal component analysis and partial least squares approaches.
Our study demonstrates that investor sentiment negatively affects aggregate future market returns and cash flows. Similarly, investor sentiment negatively affects cross-sectional future stock returns, free cash flows, firm performance, and discount rates in the Pakistani context. Our study contributes to knowledge about investor sentiment based on the market, news, and social media in Pakistan, which has not been explored before. Our findings apply as well to similar countries in Asia or elsewhere.