Cross-border sentiment: an empirical analysis on EU stock markets

Abstract

Most of the behaviour finance literature studies investor sentiment at its aggregate level. However, we argue that with the progress of economic integration and globalization, it is important to differentiate investor sentiment only confined within the market from sentiment across international markets as we have witnessed how the panic spread during the August 2007 financial crisis. Focusing on eight main EU stock market indices from March 1994 to February 2011, this article investigates different aspects of investor sentiment impact by differentiating the scope of influence of the sentiment. We find that sentiment especially developed and emerging EU stock market regional sentiments have significant impact on sample market excess returns and volatility. Since the start of the crisis, there are heterogeneous increases in different sentiment impacts. US sentiment is important in these EU markets but far from being the dominant one. Further analysis shows that regional sentiments can be transmitted across the border via interbank lending networks. In a VAR framework, we find mixed evidence regarding the predictive power of different sentiment indices on return but consistent evidence supporting the reverse relationship. Furthermore, sentiments are contagious according to the strong evidence of Granger causality between the sentiment indices.