Contagious Investor Sentiment and International Markets

Abstract

The authors use a new index of investor sentiment for six developed stock markets to determine how the correlations of sentiment impact future market return correlations. Statistical analysis reveals three findings. First, sentiment is more correlated during periods when both market returns are declining. Second, the correlations of sentiment can significantly forecast future one-year stock market return correlations. Third, the correlations of sentiment have stronger predictive power for future return correlations during bear periods than they do during bull periods for the United States and other market pairs. The authors’ findings provide a partial explanation of why return correlations between different markets increase during financial crises.