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Composite Survey Sentiment as a Predictor of Future Market Returns: Evidence for German Equity Indices

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  • Zuzana Rakovska

Abstract

In this paper, I construct a novel composite sentiment indicator which captures the irrational beliefs of the general population in Germany. This indicator is used to demonstrate that the sentiment of the general public is responsible for temporary overreactions of the aggregate German stock market and also of its narrower segments as embodied in four important equity indices from the DAX family. My results show that population-wide beliefs work as a contrarian predictor of future returns on German equity indices for horizons of six to twelve months. In addition, an out-of-sample framework is developed to underline the degree of improvement achieved by combining several survey-based measures into one composite sentiment indicator. The results reveal that the composite indicator exhibits more accurate forecasting performance than the popular sentiment measure, consumer confidence.

Suggested Citation

  • Zuzana Rakovska, 2020. "Composite Survey Sentiment as a Predictor of Future Market Returns: Evidence for German Equity Indices," Working Papers 2020/13, Czech National Bank.
    • Handle: RePEc:cnb:wpaper:2020/13
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    More about this item

    Keywords

    Composite indicator; consumer confidence; DAX indices; return predictability; sentiment;
    All these keywords.

    JEL classification:

    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G40 - Financial Economics - - Behavioral Finance - - - General
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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