Essays on the relationship between investor sentiment and stock returns

This dissertation investigates the relationship between investor sentiment, sovereign credit ratings, and sectoral index returns within G20 countries that are members of the OECD, for the period from June 2018 to April 2024. Employing a panel data analysis framework, the study explores how consumer and business confidence affect stock market performance across five major index categories: prime, energy, finance, industry, and technology. It extends previous research by integrating sovereign credit ratings alongside sentiment indices to evaluate their combined impact on the stock exchanges of G20 nations within OECD countries. Regarding sovereign credit ratings, four types of dummy variables were constructed: (i) standalone ratings, (ii) rating upgrades (iii) rating downgrades, and (iv) all rating-related changes, including outlook revisions and watchlist adjustments Although most of the existing literature typically focuses on either sovereign ratings or consumer sentiment, this research integrates both consumer and business sentiment measures alongside sovereign credit ratings to evaluate their individual, interaction, and triple interaction effects on equity returns. The analysis includes macroeconomic control variables such as CPI, exchange rates, and industrial production and incorporates the effects of COVID-19 pandemic and the Mortgage Crisis. Empirical results show that while sovereign credit ratings do not display a consistent direct impact on sectoral returns, investor sentiment, particularly business confidence plays an important and positive effect in shaping market outcomes. Consumer confidence is also found significant in the majority of cases. Moreover, sovereign credit ratings have notable interaction effects mostly observed in the energy and prime sectors through carrying sentiment effect into stock prices. Triple interaction terms involving rating, consumer and business confidence indices demonstrate a statistically significant negative effect on the energy sector. This finding indicates that the joint deterioration in sovereign credit quality, consumer sentiment, and business confidence may increase downward pressure on returns in this sector. Additionally, the study finds that among macroeconomic variables, CPI influence all sector returns whereas exchange rates influence sector-specific returns, while industrial production do not demonstrate statistical significance in general. Among the two crisis periods covered, the COVID-19 crisis dummy reveals a significant effect solely on the energy sector, highlighting its sector-specific sensitivity during the pandemic period while the mortgage crisis does not show any statistically significant effect on the performance of the analyzed indices. This thesis contributes to the literature by demonstrating a comprehensive cross-country, cross-sectoral analysis that gathers sentiment and sovereign credit risk perspectives, providing new insights into how financial markets process macroeconomic information and behavioural signals. The findings carry implications for investors, policymakers, and credit rating agencies in understanding how structural and psychological factors interact to shape equity market patterns in advanced economies.