The Relationships between Sentiment, Returns and Volatility
34 Pages Posted: 12 May 2004 Last revised: 27 Feb 2019
Date Written: January 1, 2006
Previous papers that test whether sentiment is useful for predicting volatility ignore whether lagged returns information might also be useful for this purpose. By doing so, these papers potentially overestimate the role of sentiment in predicting volatility. In this paper we test whether sentiment is useful for volatility forecasting purposes. We find that most of our sentiment measures are caused by returns and volatility rather than vice versa. In addition, we find that lagged returns cause volatility. All sentiment variables have extremely limited forecasting power once returns are included as a forecasting variable.
Keywords: Causality, Investor Surveys, Market based sentiment measures, Realized volatility, Stock index returns
JEL Classification: G12, G14
Suggested Citation: Suggested Citation