An Empirical Study on Investors’ Sentiment and Sharpe ratios of China’s Stock Market

摘要

The importance of investors’ irrationality as a possible determinant of fluctuations in Sharp ratio is welldocumented, but few empirical tests has been undertaken to investigate such relationships. This paper uses monthly data of investors’ sentiment at the individual and institutional level provided by YALE-CCER China Stock Market Investor Confidence Index to empirically test these theoretical propositions. Specifically, the paper focuses on both irrational and rational components of investors’ sentiment and investigates their relationship with Sharp ratio derived from the returns of Shanghai Composite Index. The generalized impulses generated from a VAR model reveals that, irrational optimism leads to a significant downward revision in Sharp ratio perhaps due to the excess volatility generated, while rational investors’ sentiment has an insignificant effect on Sharp ratio suggesting that rational optimism backed by strong economic fundamentals cause the changes in Sharp ratio to stay statistically insignificant.