The effect of investor sentiment on returns of JSE size-based indices under changing market conditions: Evidence from a Markov regime-switching model

Purpose: The continuous unresolved debate that arises between traditional finance and behavioural finance frameworks has dominated empirical literature in recent years. Despite this, the limited literature extends the debate to size-based indices, especially in emerging markets like South Africa that are characterised by alternating market conditions and sentiment-induced markets. Consequently, the objective of this study is to examine the effect of market-wide investor sentiment on the Johannesburg Stock Exchange (JSE) size-based indices’ returns at bullish/bearish market conditions. Methodology: The Markov regime-switching model for the period April 2007 to March 2025 reveals that market-wide investor sentiment has a regime-specific and time-varying effect on JSE size-based indices’ returns. In bullish/bearish market conditions, investor sentiment has a positive significant effect on JSE size-based indices’ returns. However, the magnitude of such effects seems too great in bearish market conditions. Similarly, the JSE size-based indices’ returns are dominated by the bearish market condition, revealing its non-resilient nature to sentiment-induced markets and market fluctuations. Theoretical contribution: The study contributes to resolving the debate in literature that arises from the efficient market hypothesis and behavioural finance frameworks, by demonstrating that JSE size-based indices present adaptive behaviour as supported by the adaptive market hypothesis. Practical implications: Investors must factor in changing market conditions and sentiment levels in the market when determining whether to invest in JSE sized-based indices as it will contribute positively or negative to prospect returns. Policymakers must devise new policy reforms that curb unstable market conditions and noise trading as it contributes directly to alternating market efficiency. Sustainable Development Goals (SDGs): SDG 8: Decent Work and Economic Growth; SDG 10: Reduced Inequalities; SDG 16: Peace, Justice and Strong Institutions