Investor sentiment and stock return predictability: evidence from global sentiment indices

In international finance, a key question concerns whether investor sentiment can predict stock returns. This study constructs three novel sentiment indices: the Emerging Market Sentiment Index (EMSI), the Developed Market Sentiment Index (DMSI), and the Global Market Sentiment Index (GMSI). These indices are derived from survey-based confidence measures after adjusting for macroeconomic influences. Using data from 38 countries spanning nearly two decades, the findings reveal that both developed and global sentiment indices positively influence stock returns over short horizons (1–2 months), whereas all sentiment indices exhibit negative and significant effects over medium to long horizons (6–36 months), particularly in emerging markets. These results underscore the role of behavioural sentiment in driving short-term mispricing and subsequent long-term reversals. The study provides new cross-country evidence on the predictive power of sentiment and its varying effects across market types, thereby contributing to the literature on behavioural finance and international asset pricing.