Investor sentiment effect on stock returns in Turkey

Ability of forecasting stock returns is one of the most investigated topics of thefinance literature. The first theory that examines the effect of psychological factors overinvestment decisions and asset prices is maintained by Kahneman and Tversky (1979).In the following years, there developed three theories that investigate the effect ofinvestor psychology over financial markets: Mental accounting theory, herd behaviorthoery and investor sentiment theory. The aim of this study is to investigate the effect ofinvestor sentiment over stock returns and evaluate the investor sentiment?s ability offorecasting stock returns. Regression models are employed to examine the effect ofinvestor sentiment over stock returns. Sample period extends from July of 1997 to Juneof 2005. In the regression models, stock portfolio returns are used as dependentvariables and investor sentiment proxies are used as independent variables. Analysisresults suggest that investor sentiment can forecast stock returns. In other words, stockprices of ISE companies have noise component. However, investor sentiment proxies donot have the same forecast power. Closed-end fund discounts, average fund flow ofmutual funds and the ratio of net stock purchases of foreign investors to ISE marketcapitalization can forecast stock returns significantly. Other investor sentiment proxiescannot forecast stock returns.Key Words: Behavioral Finance, Investor Psychology and ISE, Investor Sentiment,Noise, Stock Returns.