Academic journal article International Review of Management and Business Research

Premiums on Exchange-Traded Funds as A Sentiment Indicator: Evidence from Taiwan

Academic journal article International Review of Management and Business Research

Premiums on Exchange-Traded Funds as A Sentiment Indicator: Evidence from Taiwan

Article excerpt

(ProQuest: ... denotes formulae omitted.)


Recent literature in finance has turned to non-economic factors such as investor sentiment as possible determinants of asset prices. That motivates to study the effects of investor sentiment on asset prices comes from the fact that fundamental based models do not fully explain asset price movement in the short to medium term. Researchers have explored the possible effect of investor sentiment on asset prices. Baek et al. (2005) suggest that shifts in investor sentiment may explain short-term movements in asset prices better than any other set of fundamental factors. Brown and Cliff(2005) find evidence that investor sentiment affects future asset prices in the long run. Verma and Soydemir (2006) provide evidence that U.S. investor sentiment have strong effects not only on U.S. stock market returns but also on international stock market returns. However, whether investor sentiment affects asset prices is still open to debate.

Institutional and individual investors are two major types of investors who compete to obtain limited profitability in financial markets. Research on investor sentiment has focused on individual investors for two main reasons: (1) data on the sentiment of institutional investors are much less available; (2) the "investors" in the theoretical framework for the role of investor sentiment in determining stock prices are referred to a certain group of investors who may not be making investment decisions based on a company's fundamentals. Such "noise traders," as they are referred to, are capable of affecting stock prices by way of unpredictable changes in their sentiments and are often supposed to be individual investors.

Following the "noise trader" model of Delong et al. (1990), several empirical studies examine the influence of investor sentiment. Studies use indirect and direct measures of investor sentiment. Indirect measures of investor sentiment include the closed-end fund (CEF) discount, trading activity-based measures, market performance-based measures, IPO related measures, the dividend premium, and derivative-related variables (Verma and Soydemir, 2006). Overall, these studies do not provide a consensus on whether the proxies chosen are appropriate. They also show mixed results as to links between sentiment and stock returns. Direct measures of investor sentiment use sentiment survey data that indicate the expectations of market participants. Fisher and Statman (2000) used data from Merrill Lynch, which compiles the responses of strategists about their recommended portfolios monthly as the measure of the sentiment of the large investors. Fisher and Statman (2000) and Verma and Soydemir (2006) also use survey data from Investors Intelligence and the American Association of Individual Investors to stand for investor sentiments. Kling and Gao (2008) use daily survey data on Chinese institutional investors' forecasts to measure investors' sentiment.

CEFs have the market price in the market trading and the net asset value (NAV) calculated according to the market value of assets the funds hold at the same time. When the market price is higher than the NAV, it is the premium, while if the reverse happens it is the discount. CEFs in financial markets are generally traded by individual investors and at discounts. The discounts fluctuate violently. The investor sentiment is proposed as a tenable reason for explaining this phenomenon. The CEF discount was therefore treated as a proxy of individual investor sentiment.

However in the market with less CEF issued and listed, using CEF discount to act as a proxy for investor sentiment will be challenged. Such as Taiwan, in 1988 the first CEF was launched. From 1988 to 1998, although 30 CEFs were issued, most of them subsequently turned into open-end. After 1998, no new CEF issuance has ever occurred. As of June 30, 2003, which is the starting date for the data period for this research, only three CEFs remained in the market, and thereafter two of them also transferred to open-end in 2005. …

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