A New Principal-Component Approach to Measure the Investor Sentiment

Abstract

This paper develops a new market sentiment index for the Hong Kong stock market, one of the largest stock market in the world. The components of the sentiment measure include the turnover ratio, short-selling volume, money flow, HIBOR and return of the U.S. and Japanese markets. We also include the Shanghai and Shenzhen Composite index in our measure to capture the influence of Chinese markets on the Hong Kong market. A threshold regression model using the sentiment index as a threshold variable is estimated to capture the state of the Hong Kong stock market. It is also found that the trading rule which sells (buys) the HSI or S&P/HKEx LargeCapIndex when the sentiment index is above (below) the upper threshold value can beat the buy-and-hold strategy.