The Influence of Investor Emotion on the Stock Market: Evidence from an Infectious Disease Model

Abstract

In March 2020, four consecutive circuit breakers in the US stock market underscored the impact of investor sentiment on the stock market. With the development of technology, public opinion and other information now spread easily through social media and other channels, indirectly affecting investor sentiment. This makes it important to understand the underlying dynamics of such situations to help manage the market impact of such events going forward. To that end, we analyze investor sentiment, investor structures, and the capital market fuse mechanism using infectious disease dynamics. We use an extension of the SIR (susceptible, infectious, and recovered) model, called the dynamic SIRS model (where individuals return to a susceptible state), to simulate the impact of investor sentiment on the stock market. Accordingly, we study the circuit breakers in the US stock market and the simulation results of the model to analyze the fuse mechanism process in China that triggers a pause in the market based on volatile trading. The results of our study show that when the influence rate of investor mutual communication increases or when the emotional calm rate decreases, investor emotions will start to diffuse, leading to an increase in the probability of either a serious stampede or zealous overbuying in the stock market. At the same time, the trading frequency of investors and the ratio of investors in both buying and selling directions will have a certain formal impact on the direction of the stock market, with the final impact determined by the ratio of normal investors to emotional investors. When emotional investors dominate the market, their emotions are diffused throughout. Our study provides the reference for relevant agencies to monitor and improve the stock market fuse mechanism in the future.

An Analysis of the Influence of ESG Rating Divergence on Investor Sentiment

“…Investor sentiment refers to investors' perceptions of future cash flows and investment risks, which may not be justified by factual information and often such perceptions may be inconsistent with factual information [14] (Chen & Haga, 2021). It is an important area of research in the field of behavioral finance and plays a crucial role in influencing stock market dynamics, which means that when investor sentiment affects the demand of enough investors, the price of a security deviates from its fundamental value [15] (Mørck et al, 1990).…”

“…In addition, it is considered a cognitive bias of investors that disturbs capital markets, similar to "noise" [17] (Yang, 2022). Furthermore, exploring the relationship between investor sentiment and stock returns can reveal how investor sentiment affects the functioning of stock markets [14] (Chen & Haga, 2021). For example, a shock to investor sentiment can have a significant impact on stock market returns, especially in bull markets [18] (Hu et al, 2021), as well as causing irrational exuberance and panic declines in financial bubbles and crises [19] (Yu, 2021).…”

How Investment Portfolio Reduce the Additional Risks from Investor Sentiment

“…When investors are affected, the degree of trading volume will also be affected by investor sentiment, which will further cause market imbalances and changes. [3].…”

Dynamic analysis and optimal control of a stochastic investor sentiment contagion model considering sentiments isolation with random parametric perturbations

“…Han et al 21 proposed a set of compound methods based on wavelet, contagion entropy, and network analysis to explore the model of investor sentiment contagion among enterprises. In an effort to elucidate the influence of investor sentiment on the stock market, Chen et al 22 constructed the dynamic SIRS model based on the integration of investor sentiment, investor structure, and the capital market. The research results demonstrate that as the influence of investors’ mutual communication increases or the calm sentiment rate decreases, investor sentiment will begin to spread, leading to an increased probability of frenzied overbought conditions in the stock market.…”