Asymmetric Relationship between Investors' Sentiment and Stock Returns: Evidence from a Quantile Non-causality Test

This study investigates the causal relationship between investor sentiment and stock returns in the USA by conducting a quantile Granger non-causality test. Employing two proxies for investor sentiment - the sentiment index developed by Baker and Wurgler in 2007 and the University of Michigan Consumer Survey, a consumer confidence index - we find that the causal relationship between investor sentiment and stock returns strengthens when a tail quantile interval is considered. This finding implies that the investor sentiment could provide the incremental predictability for the stock returns under the extreme market situation, which cannot be found using a traditional Granger causality test. Interestingly, the findings can be explained by investors' loss aversion and herding behavior.