The the level of optimism or pessimism

The idea of
investor sentiment dates back to mid-twentieth when Keynes (1936) proposed that
markets are influenced by investors’ “animal spirits”, causing prices to
deviate from fundamentals. This idea is formalized by De Long et al. (1990), who theoretically
demonstrated that sentiment changes can lead to noise trading and excessive
volatility. Conventional studies identified two kinds of sentiment measures
(Lee et al. 1991; Neal and Wheatley
1998; Brown and Cliff 2004). The first sentiment measures are derived from
surveys while the second measures relied on objective variables such as consumer
confidence index, that correlate with investor sentiment. Both two measurements
have limitations as they heavily relied on some proxies as mediators to reflect
investor sentiment (Schmeling 2009; Carlin et
al. 2014).

In the first
sentiment measures, the surveys, researchers typically select a random number
of households and ask a small number of questions to identify the level of
optimism or pessimism per household. The responses are then aggregated to
construct an average sentiment level. Although these studies have provided
important insights, the survey method has some important weaknesses. One
weakness is that sample sizes and participation rates are typically low. For
example, the Michigan Consumer Sentiment survey is sent to only 500 households,
and the Consumer Confidence Index to 5000 households. Another weakness is that
the surveys are typically conducted on a monthly frequency.

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Moreover, most
of extant research only focuses on institutional investor sentiment (Gao and
Kling 2008; Verma and Soydemir 2009). The sentiment of retail investors is only
measured by proxies such as the survey of expectation (Brown and Cliff 2004;
Fisher and Statman 2000) and consumer confidence (Schmeling 2009). However,
these proxies are still not good enough to reflect the individual sentiment given
that retail investors have been holding around 50% of stock investments in U.S.
stock market.

Corresponding to
previous research weaknesses, it is important to directly measure the sentiment
of retail investors with a large sample size and high frequency. Fortunately, due
to the rapid development of online social media and sentiment analysis
techniques, social media has become a great database of society’s behaviour
where the sentiment of retail investors can be extracted. Recently, the
question is no longer whether investor sentiment affects stock market
valuation, but how to directly measure investor sentiment and quantify its
effects on stock movement.

For analysing and
understanding the correlation between social media sentiment and stock movement
in the next chapter, this chapter will firstly introduce the basic concept and
definition of sentiment analysis and social media. Finally, the theoretical
interpretation in stock market and social media will be explored.


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