Investor Sentiment, Stock Market Returns and Volatility: Evidence from the Johannesburg Stock Exchange

Traditional asset pricing theory asserts that investors are rational and, therefore, asset prices are solely influenced by fundamental factors. However, the effect of behavioural biases on asset returns has been documented in recent financial literature, leading to the questioning of the traditional financial theories. Accordingly, this study investigated whether investor sentiment has an impact on the returns and volatility of headline indices on the Johannesburg Stock Exchange market over a ten-year period. A composite broad market sentiment index was used to measure sentiment and the generalised autoregressive conditional heteroscedasticity models were used as the method of analysis. Findings show that there is a significant relationship between market returns, volatility and investor sentiment on the South African market. These findings point to the inadequacy of traditional asset pricing models as they do not take into account investor sentiment or any other behavioural component in pricing assets in spite of the evidence that they are significant risk factors. The results have implications for price discovery, risk management and policymaking – all aspects the success of which depends on the proper measurement and forecasting of volatility.