Investor sentiment and its impact on forthcoming stock returns and volatility during Covid-19:evidence from the U.S.

Abstract. The world economy has experienced a drastic decline and is facing a crisis after around 95 percent of countries in the world experienced negative economic growth contractions. COVID-19 also caused the global economy to suffer a loss of US$12 trillion (IMF, 2020). Throughout the years, major events have triggered significant drops and spikes in stock prices. In line with the findings of classical and behavioral finance, this thesis provides a thorough examination of what causes stock price fluctuations. As the classical theory was met with a lot of criticism, researchers turned to behavioral finance looking for a better understanding of the market and its participants. The resulting premise places emphasis on the fact that information is not available in an equal fashion to all market players. This led investors to rely on their personal emotions and beliefs on which they base their investment decisions. Behavioral finance argues that many investors are irrational and that investor sentiment exerts a significant impact on forthcoming returns and volatility. This paper underscores the importance of investor sentiment as a key explanatory indicator for stock price movements. The main objective of this thesis is to investigate further whether investor sentiment exerts a significant impact on future stock returns in the context of a major event, namely Covid-19. It also seeks to check whether systematic patterns appear in the way investor sentiment influences forthcoming stock market returns. This paper proposes the trading volume, the volatility index, the put-call ratio, the change in daily Covid confirmed cases, and the change in the daily confirmed deaths as five predicting variables of investor sentiment about the pandemic outbreak. This thesis provides empirical findings suggesting that during periods of severe market turbulence like the case of a global pandemic, investors’ attention to the stock market increases substantially. The results also support the findings of Baker and Wurgler (2007) who argue that Investor sentiment significantly impacts market performance regarding stock returns and volatility