Investor sentiment as a market-timing tool

Abstract

Studies in financial markets have moved away from seeking rational and numeric ways of valuing individual shares to investigating ways and means of quantifying investor behavior that in itself effects share prices. Central to the understanding of behavioural finance approaches is the role of investor sentiment. This research attempts to apply a new method of quantifying prevailing investor sentiment on the Johannesburg Stock Exchange, the South African Volatility Index, as a market-timing tool to combine momentum and mean reversion trading strategies. Synthetic portfolios were constructed and analysed using a time-series methodology. Momentum strategies with short holding periods of three months were found to generate the highest cumulative returns and the South African Volatility Index investigated to determine correlation with periods of poor performance of momentum portfolios in assessing its suitability as a market-timing tool. No significant relationship was established between investor sentiment as a leading indicator or contemporaneous effect with short term momentum returns.