INVESTOR SENTIMENT AND STOCK RETURNS OF INDIVIDUAL INVESTORS: A CRITICAL REVIEW OF LITERATURE
Abstract
Investor sentiment refers to the commonly held beliefs about objectively priced assets that influence investment decisions. Investor sentiment is part of a bigger field of study namely Behavioural Finance which was developed in an attempt to explain the decision making process of investors who rely on subjective and irrational criteria. Investors exhibit irrationality in making investment decisions by relying on beliefs and rumours that are not related to the objective value of assets. Therefore, it is argued in behavioural finance that sentiments, beliefs and instinct have an impact on the movement of asset prices and returns. This phenomenon is a fairly complex field to investigate because sentiments are volatile and intangible. Investor sentiment has attracted the interest of researchers because it seems to be a possible explanation for market crashes and also because classical finance has so far not managed to explain the bubbles and bursts happening in security exchanges around the world. The objective of this study was to establish the effect of investor sentiment, on stock returns of individual investors through a critical review of literature. Stock returns are a reflection of market trends and therefore, they are appropriate in analysing the predicting power of investor sentiments. The theoretical gap found in the review of literature was that the relationship between investor sentiment and stock returns of individual investors is not clearly defined. In addition, there were many proxies that were used to estimate investor sentiment which could have contributed to the varied results among the reviewed studies. The review also revealed contextual gaps since most of the studies on investor sentiment were conducted in developed markets which are quite different from the Nairobi Securities Exchange. A question is thus raised about the applicability of the findings of these studies to developing markets. Methodological gaps were also identified in that the papers reviewed used different models of analysis and therefore obtained varied results of the relationship. Further research could contribute to resolving the lack of consensus in literature.
Keywords: Investor Sentiment, Individual investors, Stock Returns
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