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The study examined the effect of investors’ sentiment on stock market return in Nigeria with consideration to bull and bear market cycles which most past studies neglected. The dependent variable was proxy by Stock Market Returns (SPR) while the explanatory variables were investors sentiment (SentPCA), Interest Rate(INTR), Inflation Rate (INFL) and Exchange Rate (EXRT), while bull events (positive market returns) and bear market event (negative market returns) were used as moderating variables to investors sentiment. In this study, quarterly data from 1985Q1 to 2014Q4 were collected from secondary sources such as CBN, NSE and SEC while in the estimation of the models formulated, statistical techniques which include descriptive statistics, correlation analysis, unit root test, Engel-Granger co-integration test, overparameterized and Parsimonious error correction model (ECM) were adopted. The results from the study show that investors’ sentiment had a statistically significantly relationship with stock market returns dynamics in Nigeria but when moderated for bear market cycle, the impact of investors sentiment on stock returns in Nigeria became statistically insignificant. In the case of Bull market cycle, it was observed that there was a statistically significant relationship between investors’ sentiment and stock market returns. We also found that exchange rate variation was more potent in distorting stock market returns dynamics in Nigeria than interest rate and inflation rate. Notably, inflation rate was found to have less value relevant to equity investors in Nigeria. This study therefore makes the following conclusions that investors in Nigeria’s equity market are likely to take market sentiment news and exchange rate announcement more serious than interest rate and inflation rate when investing in shares. During the bear market cycle, most equity investors would completely try to stay off the market waiting for another bull market run. The study recommends that investors and capital market participants should develop strategies for managing sentiment while policy market should develop policies that would prevent extreme market sentiment and also maintain stable exchange rate and interest rate environment that promote less volatile stock market.
Title Page ———————————————————————– i
Declaration ——————————————————————— ii
Certification ——————————————————————– iii
Dedication ———————————————————————- iv
Acknowledgement ————————————————————- v
Abstract ————————————————————————- vii
Table of Content ————————————————————— viii
List of Tables —————————————————————— ix
List of Figures —————————————————————— x
CHAPTER ONE: INTRODUCTION
1.1 Background to the Study —————————————————- 1
1.2 Statement of the Problem——————————————— 4
1.3 Objectives of the Study————————————————- 9
1.4 Research Hypotheses————————————————— 10
1.5 Significance of the Study ———————————————- 11
1.6 Scope of the Study —————————————————– 12
CHAPTER TWO: LITERATURE REVIEW
2.1 Introduction ————————————————————- 14
2.2 Concept of Investors Sentiment ————————————- 14
2.2.1 Development of Investors Sentiment —————————– 16
2.2.2 Measurement of Investors Sentiment —————————– 20
2.3 Alternative Approaches to Market Sentiment —————————- 28
2.3.1 Macro Approach ————————————————- 28
2.3.2 Micro Approach ———————————————— 41
2.4 Bull and Bear Market Cycle ———————————————— 42
2.5 Review of Empirical Literature ——————————————- 44
2.5.1 Investors Sentiment under Bull and Bear Market Cycle ——- 54
2.6 Theoretical and Conceptual Framework ————————— 60
CHAPTER THREE: RESEARCH METHODOLOGY
3.1 Introduction ———————————————————— 68
3.2 Research Method ——————————————————- 68
3.2.1 Population and Sampling Techniques —————————– 69
3.3 Model Specifications ————————————————- 70
3.4 Definition of Variables ———————————————– 72
3.4.1 Dependent Variable —————————————— 72
3.4.2 Independent Variable —————————————— 73
3.5 Data Collection ——————————————————– 81
3.6 Data Analysis Techniques ——————————————— 82
3.6.1 Error Correction Model (ECM) ———————————— 84
3.7 Justification of Data Analysis Used ————————————— 87
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS OF RESULTS
4.1 Introduction ———————————————————— 88
4.2 Descriptive Statistics ————————————————- 89
4.3 Correlation Matrix —————————————————– 93
4.4 Test of Mean Difference—————————————————– 95
4.5 Unit root test ———————————————————– 96
4.6 Co-integration test —————————————————- 98
4.7 Error Correction Model (ECM) ——————————————- 99
4.7.1 Tested Model 1——————————————————- 99
4.7.2 Tested Model 2 ——————————————————- 103
4.7.3 Tested Model 3——————————————————- 108
4.8 Summary of Findings————————————————- 112
CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 Summary ————————————————————— 115
5.2 Conclusion ————————————————————– 116
5.3 Recommendations —————————————————– 116
5.4 Limitation of the Study ———————————————— 119
5.5 Suggestions for Further Studies—————————————– – 119
5.6 Contribution to Knowledge—————————————— 120
Appendix I————————————————————— 138
Appendix II————————————————————– 139
Appendix III————————————————————- 140
Appendix IV————————————————————- 145
Appendix IV————————————————————- 150
1.1 Background to the Study
Stock market prices both in developed and emerging countries are generally believed to be responsive to economic and market fundamentals or new information. The event of 2008/2009 market crashwhich led to a wide deviation of stock prices from their fundamental value is generating questions and drawing attention to finding out if non-market and non-economic fundamentals are responsible for such deviations. The determination of equity price movement in most emerging stock markets has been discussed by scholars and researchers from the perspective of market, economic and firm-specific fundamentals.However, there has been some kind of shift in the discussion of equity price movement to favouringinvestors‘ sentiment/emotions. Investors‘ sentiment in general term refers to the attitude, emotions and biases that exhibit in the course of investment decision. Baek, Bandopadhaya and Du (2005) studies revealed that most short-term movements in asset prices such as equity are best explained by investors‘ sentiment. Similarly, Fisher and Stantunan (2000)are also of the view that investors‘ sentiment matter to asset pricing process.
Thus, in the pricing of equities and other financial assets, investors‘ attitude is of major concern for financial analyst and it is seen as a key determinant of the value of most financial assets (Huiwen, 2012). Baker and Wurgler (2006) recognized investors‘ psychology as a vital component in market pricing process of financial assets. This is because the sentiment of investors‘ may also reflect their risk profile and investors‘ emotion are displayed in different forms. In behavioural finance, emphasis is placed on investors‘ sentiment/bias such as escalation, cognitive dissonance and overconfidence bias. Escalation bias tend to exist when an investor continue to purchase a poor performing stock with the notion that the stock poor performance is temporary, this single act of investors‘ can influence the price of the stock in question positively since the investors‘ are not selling even when bad news enter into the market. In the case of cognitive dissonance the investors‘ act only when market information conforms to his belief. This therefore means that equity price moves only when the investors‘ interpretation of an event negates the market news. Shefrin and Statman (1996) stressed that prices of equities and other financial assets are determined by the level of confidence investors‘ have on the growth of a company. The investor commits overconfidence bias when he/she overestimates the growth rate of a company and concentrates on good news and this has great influence to the determination of financial assets prices.
In some studies, findings of sentiment and stock returns relationship are not in accordance with the Efficient Market Hypothesis. Fama (1970)stressed that the stock prices reflect the discounted value of expected cash-flows and the effect of irrational market participants in stock prices are removed by the rational participants. However, behavioural finance experts such as Chang, Ma, Chiu, Lin and Lee (2009a), suggest that irrational sentiment (overly optimistic/pessimistic expectations about investment risk and future cash flow) can persist and affect stock prices for significant periods of time. On the contrary, Baker and Wurgler (2006) state that stock mispricing is based on uninformed demand shocks induced by irrational investors‘ and limits to arbitrage. Brown and Cliff (2005) claim that sentiment could be a very persistent effect so, the demand shocks of irrational traders could be correlated over time leading to a strong and persistent mispricing. The limits of arbitrage prevent rational traders from eliminating this influence on stock prices since it is unclear how long the buying or selling pressure from overly optimistic or pessimistic irrational traders will persist (Shleifer & Vishny, 1997). However, every mispricing must eventually be corrected so that one should observe that high levels of investor optimism (pessimism) are on average followed by more volatile returns (Schmeling, 2009). In earlier evidence, Brown and Cliff (2005) indeed showed that there is a negative sentiment return relationship in the case of U.S. stock market.
The concern about the unbelievable crash in equity prices in Nigerian stock market seems to be directed mainly towards firm specific, market and economic fundamentals. That is, most market participants link stock market price decline to changes in output growth, exchange rate, business earnings, inflations rate, market rate of returns, government spending and money supply. The need to find out what is actually responsible for equity market price movement under bull and bear market cycle has generated more interest and has necessitated the need to integrate investors‘ sentiment as a potential explanation for equity price movement in both emerging and developed markets. Edo (2005), pointed out that the 2002 stock market upward price adjustment in Nigeria were characterised by perceived irrationality. He attributed the high equity prices movement to the irrational behaviour of market participants especially in cases when market fundamentals were not strong.
The integration of investors‘ sentiment as a major factor that affect equity prices has been viewed from different perspectives due to the problem of measuring investors‘ sentiment. The need to measure investors‘ emotion and how it determine the equity pricing process is gaining more ground in behavioural finance. In most works on investors‘ sentiment, the concept is strongly related to noise trading. Guohua (2008) revealed that investors‘ sentiment which affects financial asset prices comes from noise traders. He further stated that narrow-framing, conservatism, representativeness, overconfidence and self-attribution are some potential sentiments of investors‘ that can directly affect their investment decisions and indirectly affect prices. This is similar to the contributions of Reilly and Brown (1999).
Modern research on equity pricing or on the determinants of equity price movement is now favouring the use of fusion investing approach. Lee (2003), pointed out that fusion approach centered on the importance of integrating economic fundamentals and investors‘ sentiment in pricing financial assets. Stock market price variations are often explained by non-fundamental and fundamental factors. The non-fundamental factor is largely dominated by investors‘ sentiment while the fundamentals are proxied by unique indices such as long term market rate of returns, market risk, market demand/supply imbalance, inflation rate, exchange rate, industrial production, etc. These factors are important in predicting equity prices in most emerging capital market like that of Nigeria. This research, therefore seeks to provide a better explanation of equity prices movement in Nigeria using economic and non-fundamental factors such as investors‘ sentiment.
1.2 Statement of the Problem
Nigerian stock market started in 1960 when the Lagos Stock Exchange was opened. The market has since gained depth and breadth. The stock exchange is the pivot of the Nigerian capital market. The main participants of the Nigerian capital market are retailers, wholesalers (market makers) and institutional investors‘. The major institutional investors‘ include insurance companies and pension funds (Mapsofwold, 2009). These major players over the years have played major roles in shaping the market forces to drive market sentiment.
The performance of the Nigerian stock market shows that there have been quite a number of different bull and bear market cycle, in some cases crashes and bubbles. Using greater than 20% rule to identify market bull cycle and less than 20% to represent bear market as adopted in (Dukes, Bowlin & MacDonald, 1987), it was observed that in Nigeria from 1985 to 2008, there were about 17 bull market cycles and 8 bear market cycles. From 2008 to 2014, a consistent bear market cycle which also manifested into market crash was noted. For ten years (1999-2008), the stock market grew, soared and gained extreme strength (Amedu, 2010). The Nigerian Stock Exchange (NSE) All Share Index grew from 5,672.76 in January, 1999 to 58, 579.77 in January, 2008, showing a 933% increase. The market hit a new high in March, 2008 when the NSE all-share index hit a record 66,371.20 points, an increase of 1070%. However, the index droppedby 45.8% or 26,537.44 points to close at 31,450.78 on December 31, 2008. From March, 2009 to December 31; it dropped again by 69% or 20,827.17 points to close at 10,623.61. The question of what could have caused the bear market cycle to have manifested into market crash became a moot point. Olisaemeka (2009) and Amedu (2010), gave a detailed account of essential factors that fuelled the occurrence of meltdown in the Nigerian stock market. These factors according to the authors include; deluge of public offers and private placement, pull-out of foreign investors‘ and over-valued stock. Bear market occurs when sophisticated investors‘ begin to exit market, companies begin to post disappointing earnings, panic selling dominates and investors‘ sentiment becomes very negative (Oyetan, 2013). The crash of the Nigeria stock market has been attributed to sentiment that arise from fear of global financial crises, exit of foreign investors‘, margin calls, bad loans, low investors‘ appetite and persistent fall in prices of stock (Oyetan, 2013). Thus, the market scenario indicated bearish market cycle.This there shows that investors‘ in Nigeria stock market are expected to be risk adverse during bear market cycles.
Bearish market cycle of the Nigerian capital market led to a crash of the market capitalisation from a record high of N13.5 trillion in early 2008 to less than N4.5 trillion in early 2009,translating into certain costs and consequences that include; erosion of investors‘ confidence, vaporization of investors‘ real wealth, psychological pains and loss of jobs. The crash in the market also impacted negatively on other economic activities like consumption and investment. Many investors‘ shifted their resources to money market, real estates and other alternative investment destinations (Amedu, 2010). Market bear cycle or crash affects market sentiment negatively and if not well handled can manifest into depression of an economy, with loss of confidence, permanent capital losses, capital flight, pension funds value erosion and equity investment substitution. Extreme bear market or crash can be attributed to herd mentally, asset-liability mismatch, leverage, regulatory failure, global contagions of 2007/2009 global financial crisis, fraud and failure (Osaze, 2011). The consequence of these market crises also led to certain social-economic problems such as loss of jobs, depression, death and social violence. The 2008/2009 stock market crisis in Nigeria also brought adverse macroeconomic consequences, with the prevailing behaviour of the performance indices in Nigerian capital; it is significant to assess key macroeconomic risk factors such as interest rate, inflation and exchange rates which are necessary in the study of stock market behaviours.
Studies of bull and bear market cycles have attracted much attention in the literature, e.g., Pagan and Sossounov (2003), Rutledge, Zhang and Karim (2008), de Bondt, Peltonen and Santabarbara (2011), because cycles of bull and bear markets not only reflects the economic development and investors‘ confidence but has a significant impact on the whole economy and social welfare. This is important for all countries around the world in particular for developing countries which have emerging financial markets and are more vulnerable to global economic fluctuations and in understanding the puzzle of mixed results on stock market price determination. Edward and Magee (1992) pointed out that trading activity tends to expand as price move to the direction of the positive trend and behave in the reverse for bear market. This means that in bull or bear market trade volume, price move in a manner that generate pattern that can create questioning of the stock market efficiency and the relationship between investors‘ sentiment and stock returns.
There have been controversies among scholars, researchers and finance professionals with regards to what triggers movement in equity prices in emerging equity markets. This disagreement among financial researchers has taken a new dimension since the computation of indices for measuring investors‘ sentiment. The introduction of investors‘ sentiment as an explanatory variable in predicting equity price movement is now being considered in emerging economies and could be useful if applied to Nigeria.
In explaining stock market price dynamics in Nigeria, some studies tend to use fundamental factors that are based on Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT) models without giving consideration to investors‘ sentiments and market cycles such as bull and bear trends (see Osaze, 2000; Alile & Anao,1986; Udegbunam & Oaikhenan,1999; Omole & Falokun,1999; Emenuga 1989; Yohannes 1999; Inanga & Emenuga,1997; Edo,1996).
Based on the above observation, this study intend to incorporate investors‘ sentiment and stock market returns dynamics using CAPM, APT and PCA as an improved analysis of investors‘ sentiment. Some studies discussed investors‘ sentiment using survey or questionnaires which are often subjected to responses bias and question errors (Baker & Wurgler 2006), while others used quantitative approach which support the use of Principal Component Analysis (PCA) as a better measure ofinvestors‘ sentiment (Baker & Wurgler 2006), Zhu (2012), Chen, Tai Leung Chong and She (2013). Neal and Wheatley (1998) were the first to use three popular market ratios (composite measure, number of IPOs and fitted value of trend volume of equity traded) as indicators of investor sentiment. Baker and Wurgler (2007) and Finter, Ruenzi and Ruenzi (2010) use the Principal Component Analysis (PCA) to construct a sentiment indicator based on proxies. Earlier efforts do not include PCA along with CAPM and APT in anointing proxies. There is therefore the need to extend CAPM and APT to include PCA. This inclusion of PCA would improve analysis of investors‘ sentiment.
In addition, most studies that seek to test the relationship between investors‘ sentiment and stock returns in emerging market including Nigeria ignore the estimation error that do occur due to non-integration of bull and bear market cycle in the estimation process. While there are some works on bull and bear market cycle in developed and emerging economies, in Nigeria, the similar study that attempted to empirically examine market cycle was that of Adenola, Abdulrasshed, Babata, Atanda and Salaka (2011). The study evaluates market bubble and crashes rather than bull and bear cycle. It identified the period October 2005 to March 2008 as bubble regime and April 2008 to September 2010 as market crash regime. Sentiments are behavioural attributes that do explain reactions to values of sentiments. In stock market crashes, current prices bubbles are often driven by market sentiments. Behavioural studies are therefore necessary to enhance understanding of what determines stock returns either in a bull run or a bear runs. This study attempts to bridge empirical literature gap in emerging economies and Nigeria by including the bull and bear market cycle in the estimation error.
1.3 Research Questions
The basic questionis; do stock returns and investors‘ sentiment relationship differ under bull and bear market cycle in Nigeria? Other specific questions are to:
i. to what extent doesinvestors‘ sentiment under bear and bull stock market cycles in Nigeria differs?
ii. what extent does investors‘ sentiment significantly influence stock returns under bear market cycle in Nigeria?
iii. what extent does investors‘ sentiment impact on stock returns under bull market cycle in Nigeria?
iv. what extent does investors‘ sentiment significantly influence stock returns under bear and bull market cycle in Nigeria?
v. what extent investors‘ sentiment and macroeconomic factors jointly explain stock returns in Nigeria?
1.4 Objectives of the Study
The broad objective of the study is to analyse the effect of investors‘ sentiment on stock market returns in Nigeria, while the specific objectives of the study are to;
i. test if there exist a significant difference in investors‘ sentiment under bear and bull stockmarket cycles in Nigeria
ii. evaluate the influence of investors‘ sentiment on stock returns under bear market cycle in Nigeria
iii. assess the extent to which investors‘ sentiment influence stock returns under bull market cycle in Nigeria
iv. investigate the relationship between investors‘ sentiment and stock returns under both bear and bull market cycle in Nigeria
v. determine the extent to which investors‘ sentiment andmacro-economic factors jointly explains the systematic variations on stock returns in Nigeria
1.5 Research Hypotheses
In order to achieve the objectives of the study, the following null hypotheses are formulated for this study;
H01: There is no significant difference in investors‘ sentiment under bear and bull stock market cycle
H02: There is no significant influence between investors‘ sentiment and stock returns under bear market cycle
H03: There is a no significant impact between investors‘ sentiment and stock returns under bull market cycle
H04: There is no significant influence between investors‘ sentiment and stock returns under both bear and bull market cycle
H05: Investors‘ sentiment and macro-economic factors (interest rate, inflation rate and exchange rate) do not significantly explains stock returns
1.6 Significance of the Study
Are the movements in equity prices listed on the Nigeria stock exchange caused by investors‘ sentiment to stock market cycle matter? The answer to this question is not only of top most interest to investors‘ but also to financial security analysts and policy makers. The Investors‘ can reap huge and abnormal returns from the stock market if only they can predict the direction or behaviour of equity prices. The mistake investors‘ commit when investing can also be avoided if they can distinguish between movement in equity prices that is caused by fundamentals or those caused by mere emotions of investors‘.
The policy makers will also find this work useful in understanding the potential causes of stock market booms or crashes and how non-market fundamentals such as investors‘ sentiment can drive equity market prices. Stock Market regulators as policy makers will find
the results helpful in formulating and implementing stock market intervention policies that could prevent bull and bear market from destroying shareholders wealth.
This study would also be relevant to investment and professional money/asset managers, as it would provide a better explanation for short and long-run factors that are responsible for the movement in equity prices in an emerging capital market such as the Nigerian stock market.It will also assist them in identifying investment approaches, pursuing available investment opportunities and reducing the probability of high value losses in the market.
This research would also be relevant to readers and researchers who would want to understand how economic, market fundamentals and investors‘ emotions jointly influence the behaviour of equity prices in Nigeria. This study will also open new research issues for future researchers. Lastly, business owners and managers will also benefit from this study as it would provide insights into stock price movement under bull and bear market cycle. This will enable them determine the best stock market and economic condition that will favour listing their shares on the exchange.
1.7 Scope of the Study
This study focuses on investors‘ sentiment and stock market returns in Nigeria. Literature on investors‘ sentiment has become extremely extensive in recent times. The literature indicates a large volume that may require inordinate amount of time. The study therefore, does not cover the entire spectrum of the literature.
The study used quarterly time series data for the period 1985 to 2014, even though it hasset aside weekly and monthly effects. The study hastried to minimize this bias through the use of
longer time-period in relation to Bull and Bear market cycle as suggested by Lo and MacKinlay (1988).The study used time series analysis with two market regimes, namely: Bull (average upward rise in prices) and Bear (average fall in prices).