Investor Trading Behavior, Market Liquidity and the Role of

Investor Sentiment

Wei-Peng Chen, Junmao Chiu, Huimin Chung, Keng-Yu Ho

_____________________________________________________________________

ABSTRACT
This paper sets out to explore the relationship among investor sentiment, market
liquidity, and trading behavior. We classify the states of „fear and exuberance‟ as the
shorter-term sentiments of investors towards future returns, with the traditional
„bearish and bullish‟ states being identified as the medium-term sentiments. Our results
show that „bearish‟ and „fear‟ sentiments induce more sell orders along with a
reduction in market liquidity, and vice versa. As for the interaction between
shorter-term and medium-term sentiments, our findings show that when institutional and
individual sentiment is bearish and the investors‟ fear sentiment increases, investors would
decrease their net buying volume and market liquidity. In addition, the trading behavior
of individual investors is more sensitive than institutional investors in bearish state
when investors are more fearful of the future market movements. Finally, we find that
when investors feel more „fear‟ sentiment based on institutional sentiment in a bullish
state, they are likely to increase sell orders and the overall level of liquidity. We
suggest that the findings obtained from our exploration of the relationship between
investor sentiment and net buying volume could help to provide a better understanding
of the relationship between investor sentiment and market liquidity.
Keywords: Fear sentiment; Exuberance sentiment; Bearish sentiment; Bullish
sentiment; Net buying volume; Market liquidity
JEL Classification: G10; G11; G14


Wei-Pen Chen is with the Department of Finance, Shih Hsin University, Taiwan; Junmao Chiu and Huimin
Chung (the corresponding author) are both with the Graduate Institute of Finance, National Chiao Tung
University, Taiwan, and Keng-Yu Ho is with the Department of Finance, National Taiwan University,
Taiwan. Address for correspondence: Graduate Institute of Finance, National Chiao Tung University, 1001
Ta-Hsueh Road, Hsinchu 30050, Taiwan; Tel: +886-3-5712121, ext. 57075; Fax: +886-3-5733260; e-mail:
chunghui@mail.nctu.edu.tw.
1
1. INTRODUCTION
This paper sets out to examine whether the two types of investor sentiment, „bearish

versus bullish‟ and „fear versus exuberance‟, affect the trading behavior of market

investors, as well as the ways in which such sentiment can affect market liquidity.

Most of the previous studies on „bullish versus bearish‟ sentiment and market return

frequently use Investor Intelligence (II) and American Association of Individual

Investors (AAII) indicators.1 The typical forecast horizon of the newsletter for II is

from one to three months (Han, 2008), and AAII provides an indication as to where

individual investors expect the stock market to be in six months time (Brown and Cliff,

2004). Therefore, both II and AAII sentiment indicators can reveal the medium-term

expectations of stock market investors.

With regard to the „fear versus exuberance‟ investor sentiments, although Whaley

(2000) argues that the implied volatility index (VIX) is the investor fear gauge, Low

(2004) nevertheless suggests that this index encompasses not only fear but also

exuberance sentiments. While some of the recent studies use the market-based fear

sentiment index, implied option volatility and the put-call ratio, when predicting future

returns,2 other studies have also used the investor fear sentiment indicators, such as high

VIX level and high put-call ratio to proxy bearish investor sentiment (Simon and

Wiggins, 2001). According to their features, the above two measures could be used to

1
Examples in the literature on the II sentiment index include Siegel (1992), Solt and Statman (1988),
Clarke and Statman (1988), Shefrin (1999), Fisher and Statman (2000, 2003, 2006), Lee et al. (2002),
Brown and Cliff (2004, 2005), Wang et al. (2006), Liu (2006), Schmeling (2007), Han (2008), Kurov
(2008), and Ho and Hung (2008). Studies on the uses of the AAII sentiment index include Brown (1999),
Bange (2000), Fisher and Statman (2000, 2003), Brown and Cliff (2004, 2005), Liu (2006), Wang et al.
(2006), Schmeling (2007), and Kurov (2008).
2
Examples in the literature using VIX/VXN as the fear sentiment indicators include Whaley (2000),
Simon and Wiggins (2001), Simon (2003), Low (2004), and Bauer et al. (2009). On the other hand,
Simon and Wiggins (2001), Wang et al. (2006), Dennis and Mayhew (2002), and Bauer et al. (2009) use
the put-call ratio as the fear sentiment indicator.

2
gauge the shorter-term investor expectations of the future returns of the underlying assets.3

Whether investors‟ shorter-term and medium-term expectations have an impact on

market liquidity and investor trading behavior are both examined in this study. The

focus of the theoretical models has invariably been placed on the ways in which such

sentiment affects market liquidity (Baker and Stein, 2004; Deuskar, 2005). To the best

of our knowledge, no studies have yet been undertaken to document these issues

empirically. Our primary aim is to use these results to provide a better understanding of

the relationship that exists among investor sentiment, market liquidity, and trading

behavior. We try to provide empirical evidence by examining whether „bearish versus

bullish‟ and „fear versus exuberance‟ sentiments have significant impacts on market

liquidity and net buying volume (buyer-initiated volume minus seller-initiated volume).

We then attempt to separate the bullish and bearish components of the institutional and

individual sentiment indicators and examine whether different relationships are

discernible among sentiment, net buying volume, and market liquidity based on bullish

and bearish sentiment. Finally, we examine market liquidity and trading behavior based

on the interaction between shorter-term and medium-term investor expectations.

Our study makes a number of contributions to the extant literature. First, we

examine the relationships among „bearish versus bullish‟ sentiment, liquidity, and net

buying volume using the institutional and individual sentiment indicators; we also

determine whether there are any systematic differences in the influence of the bearish

and bullish sentiment. Our results indicate that more bullish investor sentiment leads to

an increase in both buy orders and market liquidity, thereby providing support for the

theoretical models of Baker and Stein (2004), Deuskar (2005); furthermore, we also find

that bearish and bullish sentiments have different impacts on market liquidity and

3
The weighting scheme is such that the composite quantity represents the implied volatility of an
at-the-money S&P 100 option hypothetical over a 30 calendar-day (22 trading-day) period.
3
investor trading behavior in individual stocks.

Secondly, our objective is to provide a better understanding of the relationships that

exist in which „fear versus exuberance‟ sentiment can affect investor trading behavior

and market liquidity. We find that an increase in fear sentiment amongst investors

decreases net buying volume and reduces market liquidity; the relationship between net

buying volume and the sentiment component of implied volatility could help to explain the

relationship between the implied volatility index and stock index returns reported by Gito

(2005).

Third, based upon the theoretical model of Baker and Stein (2004), we

hypothesize that the different trading cost can affect the relationships among investor

sentiment, market liquidity, and trading behavior. In contrast to Liu (2006),4 we try to

examine if there is any systematic difference between ETFs and individual stocks with

regard to the relationships among sentiment, market liquidity, and net buying volume.

The results indicate that, when investors become more bearish, there is likely to be a

greater reduction in the market liquidity of individual stocks than ETFs. Howoever, the

reduction in the net buying volume for individual stocks is less than that for ETFs. We

note that such phenomenon is more prominent for institutional sentiment.

Finally, we explore the interaction between shorter-term and medium-term investor

expectations; our results could provide a better understanding of how investor expectations

affect the investors‟ trading decisions and market liquidity. The results show that when

institutional and individual sentiment is bearish and the investors‟ fear sentiment increases,

investors would decrease their net buying volume and market liquidity.5 However, when

investors are fearful of the future returns on the underlying assets in an institutional

4
Using a monthly Amihud illiquidity measure that was computed from common stocks on the NYSE
and AMEX, as well as sentiment indicators which included institutional, individual and consumer
sentiment, Liu (2006) proved that more bullish sentiment can help the market become more liquid.
5
Our results are similar to the findings of Hammed et al. (2009).
4
bullish state, more sell orders would occur in the market than normal in our research

samples, which results in an increase in the market liquidity of individual stocks.

Furthermore, the trading behavior of individual investors is more sensitive than

institutional investors when investors are more fearful of the future market

movements.

The remainder of this paper is organized as follows. Section 2 provides a extant

literature review and our hypothesis development. Section 3 describes the sample

selection procedure and research methodology. Section 4 reports and analyzes the

empirical results. Finally, the conclusions drawn from this study are presented in Section

5.

2. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT

In this study, we try to provide a deeper understanding of whether investor sentiment

affects the market trading behavior of investors and leads to a change in market liquidity.

We begin by constructing the four hypotheses proposed in this study.

Two different theoretical models are used to examine the relationship between

investor sentiment and market liquidity. The first model, which was based on short

sales constraints, was constructed by Baker and Stein (2004) who demonstrated that

liquidity is increased by a class of irrational investors who under-react to the private

information contained in the order flow; thus, they argue that bullish sentiment is

associated with an increase in market liquidity. Deuskar (2005) then went on to

propose a model to demonstrate the relationship between investor sentiment and

market liquidity based upon the argument of an association among high perceived

volatility, low current prices, high expected returns, and the nervousness of investors.

Therefore, his model is concerned largely with low investor sentiment.

A growing body of literature examines the effects on market prices attributable to

5
bullish and bearish investor sentiment, return volatility, and the prediction of future

returns.6 For example, from their empirical study, Lee et al. (2002) find a negative

relationship between a bullish shift in sentiment and market volatility. High perceived

volatility predicts lower liquidity; therefore, when investor sentiment becomes more

bullish, an association may be discernible between lower market volatility and

improved market liquidity, which leads to the first of our hypotheses:

Hypothesis 1: Bullish (Bearish) investor sentiment improves (reduces) market

liquidity.

Since investors‟ arbitrage capacity is limited, they would be unwilling to bear the

excess risk. According to the „prospect‟ theories (Kahneman and Tversky, 1979) and

the „disposition effect‟, investors that can invest will tend to hold their positions or

reduce their trading activity when they are experiencing losses. The prior literature

points out that investors are more fearful of the potential loss during the down market

period than the potential gain that they enjoy during the up-market period (Benartzi and

Thaler, 1995). As a result, when they have more fear sentiment, investors will hold

their long position or reduce their trading activity, as a result of which there will be a

decline in market liquidity. We propose our second hypothesis, as follows:

Hypothesis 2: According to the ‘prospect’ theories and ‘disposition effect’, fear

(exuberance) investor sentiment reduces (increases) market liquidity.

The evidence provided by Baker and Wurgler (2006) is consistent with the notion

that the demand for stocks by uninformed investors is driven by investor sentiment;

thus, investors buy stocks when they are bullish, thereby driving up stock prices and

pushing down subsequent returns. Furthermore, there is a tendency amongst noise

6
Examples include Lee et al. (2002), Brown and Cliff (2004), and Wang et al. (2006).
6
traders to trade more when they are bullish than when they are bearish (Baker and

Stein, 2004). Given that noise traders are prone to trend chasing, one can expect

positive feedback trading to be more prevalent when investors are optimistic.

There are also a few studies which suggest that the weather may affect the mood

and sentiment of investors. It is also noted that when investors are in a generally

pessimistic mood, they will have less desire to trade. Therefore, they may tend to sell

rather than buy (Loughran and Schultz, 2004; Goetzmann and Zhu, 2005; Chang et al.,

2008), which leads us to the following hypothesis:

Hypothesis 3: Where investor sentiment becomes more bullish (bearish), this will

lead to an increase (reduction) in net buying volume.

According to Whaley (2000), when fear sentiment is high amongst investors, there

will be a rise in demand for put options to protect their long positions, which would lead

to an increase in both implied volatility and the put-call ratio. Fear sentiment provides an

indication of investors‟ short-term expectations for the future returns of the underlying

assets, with the capacity for arbitrage by investors being limited in various ways,

including short horizons, costs, and both trading and short-selling risks; given that such

investors are risk averse, they will be unwilling to bear these risks.

Therefore, when investors are more fearful of the future returns on the underlying

asset, they will be reluctant to short-sell the stock and may tend to participate by

buying fewer stocks or by closing out their existing long positions. Thus, sell orders

will dominate buy orders, which leads us to the following hypothesis:

Hypothesis 4: Where investors exhibit fear (exuberance) regarding the future

returns on the underlying asset, they will reduce (increase) their net

buying volume.

7
3. RESEARCH METHODOLOGY
3.1 Sample Selection

In order to compare whether the different trading cost affects the relationships among

investor sentiment, market liquidity, and trading behavior; we use data from both ETFs

and individual stocks. Because the VIX (VXN) index is a weighted average of the

implied volatility of S&P 500 (NASDAQ 100) index options, we select SPY ETFs (the

exchange-traded funds which track the S&P 500 Index) and QQQQ (the

exchange-traded funds which track the NASDAQ 100 Index), and then follow

Ascioglu et al. (2007) using the matching firm approach to find two NYSE stocks and

two NASDAQ stocks for each of our ETF.

We identify all individual stocks listed on the NYSE and NASDAQ exchanges

between January 2001 and December 2007 from the CRSP database and search the

NYSE Trade and Quote (TAQ) database daily summary statistics file to obtain the

daily statistics, such as the daily volume, average daily price, and standard deviation of

daily returns on all of the NYSE- and NASDAQ-listed individual stocks. We then

estimate a matching statistic for each NYSE (NASDAQ) stock and SPY (QQQQ) pair,

as follows: C  C12  C22  C32 , where Ci is the (DIS - DETF)/[(DIS + DETF)/2] for

statistics i; the DIS are the individual stock daily statistics; and the DETF are the ETF

(SPY, QQQQ) daily statistics. We calculate the total matching statistics for the

individual stock-ETF pairs and also exclude the individual stocks relating to Regulation

SHO.7 Those firms with matching statistics which are lower than, or close to 0, are

better matching stocks for each ETF.8 Finally, we select GE (General Electric Co.) and

PFE (Pfizer Inc.) as the matching firms for the SPY and AAPL (AAPL Inc.) and MSFT

7
Regulation SHO (Reg.SHO) provides a new regulatory framework governing the short selling of
securities in the US equity markets. Starting from 2 May 2005, roughly 1,000 US stocks (so-called Pilot
Stocks) were traded without short-sale price tests (Diether et al., 2009).
8
The results are not reported here in order to save space; however, they are available upon request.
8
(Microsoft Corporation) as the matching firms for the QQQQ.

In this study, we employ intra-day data on ETFs and individual stocks taken from

the TAQ, using the daily abstract trading and quotes data from 9:30 am to 4:00 pm. We

follow previous literature on controlling different trading mechanism and include all the

data in AMEX, NYSE, NASDAQ and NYSE Arca (Archipelago) exchanges for our

samples. The period under examination is the post-decimalization period which runs

from 29 January 2001 to 31 December 2007; this period contains the dotcom bubble

industry cycle as well as the sub-prime mortgage crisis period. We note that AAPL and

MSFT are listed on the NASDAQ, where tick-size decimalization differs from the

convention used on the NYSE; thus, the data ranges from 26 March 2001 to 31

December 2007 for AAPL, and from 9 April 2001 to 31 December 2007 for MSFT

(post-decimalization). Following Chordia et al. (2002), the observations are dropped

from the sample for the year when AAPL and MSFT switched from a NASDAQ to a

NYSE listing. Finally, according to Huang and Stoll (1996) and Chung (2006), we

eliminate the quote and trade data from our research sample.

3.2 Measures of Bearish and Bullish Sentiment

Following Brown and Cliff (2004), we collect the direct measures of bearish and

bullish sentiment from the Investor Intelligence (II) and American Association of

Individual Investors (AAII). The II is collected by categorizing approximately 150

market newsletters each week. Following the reading of the newsletters, the market is

classified as bullish, bearish, or neutral based on the expectations of future market

movements. The AAII is released by the American Association, a non-profit

organization, which asks each individual investor where they expect the stock market

will be in six months, and the results are classified as bullish, bearish, or neutral.

Hence, the II and AAII are the sentiment indicators of the medium-term expectations

9
of the institutional and individual stock markets. In the present study, we follow Wang

et al. (2006) to adopt the ratio of the bearish and bullish percentages as our measures

of investor sentiment; when they are higher (lower), market investors demonstrate

more bearish (bullish) sentiment.

3.3 Measures of Fear and Exuberance Sentiment

We use the sentiment components of the implied volatility indices, VIX and VXN, and

the put-call ratio to measure investor fear versus exuberance sentiment. The VIX (VXN)

index, computed from the Black-Scholes model, represents the implied volatility of S&P

100 index (NASDAQ 100 index) options traded on the CBOE.

According to the prior studies, several studies on S&P 100 index options find that

implied volatility contains historical volatility and has the capability of forecasting future

volatility (Day and Lewis, 1992; Christensen and Prabhala, 1998). Theoretically, implied

volatility may be influenced by sentiment, as noted in the heterogeneous beliefs model

proposed by Shefrin (2002). Several empirical studies show that sentiment has impacts

on implied volatility (Vlad, 2004; Deuskar, 2006); Fleming (1998) also argues that

implied volatility may be an effective measure of market sentiment, noting that it contains

information conveyed by historical volatility and additional information of relevance to the

prediction of volatility.

Thus, implied volatility should contain investor sentiment components and a

volatility component which could affect market liquidity (Domowitz et al., 2001). We

thus decompose implied volatility into volatility and sentiment components. The

regression approach is often used within the prior literature to orthogonalize the

variables (Banerjee et al., 2007); for example, Baker and Wurgler (2006)

orthogonalized their raw sentiment proxies by regressing them on macro variables,

using the residuals as pure sentiment proxies. In the present study, we decompose

10
implied volatility into its volatility and sentiment components by regressing the

implied volatility index on one-year historical volatility, and we refer the residuals to

the sentiment components of implied volatility. These pure sentiment proxies are

capable of capturing the shorter-term expectations of investors regarding the future

returns on the underlying assets. Hence, we define the VIX and VXN sentiment

components as the measure for investor fear sentiment.

The put-call ratio (PCR) is another measure of investor market sentiment

calculated through the use of options. It is equal to the total trading volume of the put

option contracts divided by the total trading volume of the call option contracts (Simon

and Wiggins, 2001). The PCR is also viewed as an indicator of investor fear. Whilst

the data on the VIX and VXN sentiment components and the put-call ratio are all

daily-based, the AAII and II sentiment indicators are all weekly-based. In order to

resolve this data frequency problem, we adopt the method whereby each trading day of

a week has the same value as the beginning of the week.

3.4 Liquidity and Net Buying Volume Variable

We use the percentage spread as the illiquidity proxy. The formula for the percentage

spread is (Askt – Bidt)/[(Askt + Bidt)/2], where Askt and Bidt are the respective intraday

ask and bid prices at time t. We then calculate the average of all the percentage spreads

in one day as the liquidity variable and use the algorithm proposed by Lee and Ready

(1991) to distinguish between all transactions that are buyer and seller initiated. The

algorithm classifies a trade as a buyer (seller) initiated trade if the traded price is higher

(lower) than the mid-point of the bid and ask price. We assign a value of +1 (–1) where it

is clear that each transaction is a buyer (seller) initiated trade, multiply the signals by

trade volume, and sum up the multipliers that occur each day. As a result, we can

ascertain whether each trade arises from buying or selling pressure, which provides the

11
net buying volume variable. Finally, we standardize the net buying volume variable by

dividing net buying volume by trading value. Therefore, the percentage standardized net

buying volume is the net buying volume variable used in our analysis.

4. EMPIRICAL RESULTS
4.1 Basic Statistics

As we can see from Table 1, the summarized statistics show that LogV (V is the daily

trading volume) is found to be larger for ETFs than for individual stocks, and the

median spread and net buying volume in SPY are both smaller than those of GE and

PFE. In addition, both individual (AAII) and institutional (II) investors are more

bullish in our sample period, especially institutional investors. Finally, we show from

the correlation statistics of the sample variables that the VIX/VXN sentiment

indicators used in our study have more sentiment components and lower volatility

components than the VIX/VXN indices.9 Thus, we argue that in the examination of

the relationship among the degree of investor uncertainty (or fear sentiment), liquidity,

and net buying volume, our implied volatility sentiment components are better proxies

than the standard implied volatility indices.

<Table 1 is inserted about here>

4.2 Investor Sentiment, Liquidity, and Net Buying Volume

We first examine the relationship between „bearish versus bullish‟ sentiment and

market liquidity using the Institutional and Individual variables and investigate the

following regression model in order to control for those factors which may be of

importance in determining the spread:

4
SPt    1SPt -1   2 LogVt   3 Ret t  ∑ 4i DtWK 
i 1
, (1)
 5 Institutio nalt   6 Individualt   t

9
The results are not reported here in order to save space; however, they are available upon request.
12
where SPt is the daily average of the percentage spread for ETF/individual stock on

day t, Vt is the daily trading volume, Rett is the daily return, the DtWK are the day of the

week dummies, and Institutional (Individual) is the II (AAII) measure, which is the

ratio of the bearish percentage to the bullish percentage on day t. The results in Panel A

of Table 2 show that the relationships between Institutional, II, and spread are

significantly positive in all of our samples with the exception of MSFT, whereas in

terms of the relationships between Individual, AAII, and spread, only MSFT is

significantly positive.

These results provide support both for our hypothesis and the theoretical models

of Baker and Stein (2004) and Deuskar (2005), demonstrating that with more bullish

investor sentiment, investors would be more inclined to trade in the market, thereby

improving market liquidity. The results also provide support for Lee et al. (2002) by

implying that bullish sentiment is associated with higher market liquidity, lower

volatility, and low expected returns. Moreover, we find that institutional sentiment has

a more significant effect on market liquidity than individual sentiment.

We then carry on to examine the relationship between „fear versus exuberance‟

sentiment and market liquidity using the VIX/VXN and PCR variables and investigate

the following regression model in order to control for those factors which may be of

importance in determining the spread:

4
SPt     1 SPt -1   2 LogVt   3 Ret t  ∑ 4i DtWK 
i 1
, (2)
 5 (VIX / VXN ) t   6 PCR t   t

where the VIX/VXN variables are the sentiment components of the VIX/VXN indices

on day t, and PCR is the put-call ratio, which is the total trading volume of the put

option contracts divided by the total trading volume of all call option contracts on day t.

The remaining control variables are the same as in Equation (1). As we can see from

Panel B of Table 2, „fear versus exuberance‟ sentiment is significantly and positively

13
correlated with the contemporaneous percentage spread; we also note that the VIX

indicator is significant in SPY and PFE, and that the VXN indicator is significant in QQQQ

and AAPL. PCR is significant in GE, PFE, QQQQ, AAPL, and MSFT. As a result, an

increase in PCR and the VIX/VXN components leads to increase market spread.

<Table 2 is inserted about here>

Since the capacity for arbitrage by investors is extremely limited, they will tend to

be risk averse; thus, when investors are more fearful of the future returns on the

underlying assets, they will demonstrate their reluctance to engage in the short-selling

of stocks. Such investors are therefore likely to either hold their current long positions

or reduce their overall trading activity, with a resultant reduction in market liquidity.

These results provide support for our second hypothesis. Finally, by using our

aggregate sentiment indicators, we find that the impact on the liquidity of individual

stocks listed on the NYSE is likely to be more sensitive than the corresponding impact

on ETFs.

Secondly, we examine whether investor sentiment could affect net buying volume.

By following Chordia et al. (2002) to control for the factors that may be of importance

in determining net buying volume, we examine the relationship between „bearish

versus bullish‟ sentiment and net buying volume, using the following regression

model:
5 5 5
OIBNUM t    ∑ 1i OIBNUM t - j  ∑ 2i Max(0, Ret tj )  ∑ 3i Min (0, Ret tj ) 
j 1 j 1 j 1
, (3)
4
 4 LogVt  ∑ 5i DtWK   6 Institutio nal t   7 Individual t   t
i 1

where OIBNUMt is the standardization percentage net buying volume variable, which is

the number of buyer-initiated trades less the number of seller-initiated trades divided by

the total number of ETF trades in individual stock on day t.10

10
The remaining control variables are the same as those in Equation (1).
14
 In Panel A of Table 3, the relationship between individual sentiment and net buying

volume is significantly negative for GE and PFE, whereas institutional sentiment is

significantly negative for SPY. During a period of bullish investor sentiment, investors

have greater optimism and more desire to trade, with noise traders demonstrating a

penchant for trend chasing; thus, we expect to find a greater prevalence of positive

feedback trading, with investors demonstrating a general tendency to buy rather than sell.

Our results indicate that the research samples listed on the NYSE support our Hypothesis

3.

<Table 3 is inserted about here>

We then examine the relationship between „fear versus exuberance‟ sentiment and

net buying volume and investigate the following regression model:

5 5 5
OIBNUM t    ∑1i OIBNUM t - j  ∑ 2i Max(0, Ret tj )  ∑ 3i Min (0, Ret tj ) 
j 1 j 1 j 1
, (4)
4
 4 LogVt  ∑ 5i DtWK   6 (VIX / VNX ) t   7 PCRt   t
i 1

where the VIX/VXN variables and PCR are the same as in Equations (2). As shown in

Panel B of Table 3, the market sentiment indicators have a strong negative correlation

with contemporaneous net buying volume. We find that the VIX is significant in both

SPY and GE, and that the VXN is significant in QQQQ, whilst PCR is significant in all

of the ETFs and individual stocks with the exception of AAPL. Furthermore, our

sentiment indicators have more significant effects on net buying volume in the ETFs and

individual stocks listed on the NYSE than those listed on the NASDAQ. Finally, we find

that both the Institutional and VIX/VXN sentiment indicators have more significant

impacts on the net buying volume of ETFs than individual stocks. Since all of our

sentiment indicators are aggregate measures, the aggregate sentiment indicators may

have more direct effects on the ETFs tracking the S&P 500 and NASDAQ 100 indices

than on individual stocks. Therefore, the sentiment indicators have larger impact on the
15
net buying volume for ETFs than for individuals stocks. In addition, it is noted that the

market depth of ETFs could be deeper than individual stocks. Such phenomenon further

leads to the smaller effect of the sentiment indicators on market spread for ETFs,

compared to individual stocks.

These results provide support for Hypothesis 4 to the effect that if investors have

uncertainty with regard to the future returns on the underlying assets (i.e., where the

VIX/VXN variables and PCR are higher), this will reduce the buy orders in the market.

Our results may therefore help to explain the relationship between the implied

volatility index and stock index returns found by Gito (2005), who reported a positive

relationship between implied volatility and forward-looking stock index returns.

Gito (2005) surmised that “if, as thought by some market practitioners, large or

very large implied volatility levels do indeed indicate oversold markets, then the

forward-looking returns for long positions in the underlying stock index triggered by

these large implied volatility levels should be attractive”. We suggest that this could be

caused by investors who are fearful of the future returns on the underlying assets, in

which case both the VIX/VXN components and PCR become higher, thereby resulting

in diminished net buying volume in the market.

4.3 Bearish and Bullish Sentiment, Liquidity, and Net Buying Volume

When the „bearish versus bullish‟ sentiment indicators (II and AAII) are higher than 1, it

means that for most investors, their expectations with regard to the future returns of the

underlying assets will be more bearish than bullish. In other words, aggregate sentiment

in the market is bearish. This provides us with an opportunity to compare the way in

which market liquidity and trading behavior may be affected by bullish and bearish

sentiment. First, we identify the relationship among bearish sentiment, bullish sentiment,

and market liquidity by investigating the following regression model in order to control

16
for the factors that may be of importance in determining the spread:
4
SPt    1SPt -1   2 LogVt   3 Ret t  ∑ 4i DtWK   5 Institutio nalt  D Inst 
i 1
, (5a)
 6 Institutio nalt  (1 - D Inst )   t
4
SPt     1 SPt -1   2 LogVt   3 Ret t  ∑ 4i DtWK   5 Individal t  D Ind 
i 1
, (5b)
 6 Individualt  (1 - D Ind
)  t
Inst
where the dummy variable D is equal to 1 on days when the II indicator is equal to
Ind
or greater than 1, and D is equal to 1 on days when the AAII indicator is equal to or
Inst Ind
greater than 1. The variables Institutional × D and Individual × D therefore

indicate that institutional and individual investors expect future market movements to

be bearish rather than bullish, and vice versa.

The empirical results are presented in Table 4, from which we can see that the
Inst
relationship between Institutional × D sentiment and market liquidity is significantly

positive in all of the samples with the exception of MSFT. In addition, the significantly
Ind
positive relationships are discernible between Individual × D sentiment and market
Inst
liquidity, and are significantly positive for both SPY and MSFT. Institutional × (1– D )

sentiment is significantly positive for SPY, GE, PFE, and QQQQ. We then examine

whether there are any systematic differences in the influence of the bearish and bullish

sentiment. We find that there are systematic differences between Institutional bearish

and bullish sentiment in GE, PFE, and AAPL, whereas in the relationship between

Individual bearish and bullish sentiment, only GE is significant. These results show that

there are systematic differences between bearish and bullish sentiment in individual

stocks for market liquidity.

<Table 4 is inserted about here>

All of these results provide support for our Hypothesis 1; furthermore, we can see

that the institutional investor sentiment indicator (II) affects market liquidity more

significantly than the individual investor sentiment indicator (AAII), particularly for
17
 Inst
Institutional × D . Most of our research results indicate that sentiment has a more

significant impact on the market liquidity of individual stocks than of ETFs, since the

individual stocks are affected by short-sales constraints, with arbitrage in such stocks

tending to be particularly risky and costly. When mispricing is at its highest level,

volatility in individual stocks may be higher, in which case investors may provide more

funds for arbitrage activities or short selling; this would tend to result in a greater

reduction in the market liquidity of individual stocks than ETFs (Baker and Stein, 2004).

As a result, from our comparison between ETFs and individual stocks, we find that the

latter have more sensitive relationships between investor sentiment and market

liquidity.

Next, we examine the relationships among bearish sentiment, bullish sentiment

and net buying volume. We investigate the following regression models according to

Equation (3), with the results being reported in Table 5:

5 5 5
OIBNUM t    ∑ 1i OIBNUM t - j  ∑ 2i Max(0, Ret tj )  ∑ 3i Min (0, Ret tj )   4 LogVt 
j 1 j 1 j 1 , (6a)
4

∑ 5i DtWK   6 Institutio nal t  D Inst   7 Institutio nal t  (1 - D Inst )   t

i 1

5 5 5
OIBNUM t    ∑ 1i OIBNUM t - j  ∑ 2i Max(0, Ret tj )  ∑ 3i Min (0, Ret tj )   4 LogVt 
j 1 j 1 j 1 , (6b)
4

∑ 5i DtWK   6 Individual t  D Ind   7 Individual t  (1 - D Ind )   t

i 1

Inst Ind
where the dummy variables Institutional × D and Individual × D are the same as

in Equations (5a) and (5b).

<Table 5 is inserted about here>

Inst
As we can observe from Table 5, both Institutional × D and Institutional × (1–
Inst Ind
D ) are negatively significant for SPY, while Individual × D is significantly negative
Ind
for SPY, GE, PFE, and QQQQ, with Individual × (1– D ) being significantly negative

in only SPY and PFE. In addition, we also find significantly negative relationships

18
among bearish sentiment, bullish sentiment, and net buying volume for ETFs (SPY,

QQQQ), while the results for in our research on individual stocks are only a negative but

insignificant. These results provide support for our Hypothesis 3. In addition, most of

our findings suggest that individual bearish sentiment has a more significant impact on

net buying volume than individual bullish sentiment. Our results are similar to those of

Gleason et al. (2004). 11 Furthermore, there are systematic differences between

Institutional bearish and bullish sentiment in PFE and MSFT, whereas in terms of the

relationship between Individual bearish and bullish sentiment, only PFE is significant.

Overall, we find that there are systematic differences between bearish and bullish

sentiment in individual stocks for net buying volume.

We also find that the relationship between institutional sentiment and net buying

volume is more significant in ETFs than in individual stocks, a result which is

consistent with the results of Equation (3). Since financial intermediaries and hedge

funds often trade and hedge their activities in the ETF markets, the net buying volume

of ETFs may therefore be more sensitive to institutional sentiment than individual

stocks.

4.4 The Interaction between Shorter-term and Medium-term Expectations

In this section, we examine whether the interaction between shorter-term and

medium-term expectations affects market liquidity and the trading behavior of

investors. When investors envisage a rise in the stock market in six months‟ time, the

bullish percentage will be higher than the bearish percentage; however, unexpected

negative news could raise investor fear sentiment, since investors are more concerned

with the potential for a short-term loss, and they are unwilling to bear the short-term

11
They examine the good news and bad news in the up and down markets. Their results indicate that
investors could be more inclined to engage in herding behavior in the down market.
19
excess risk in the future. Investors will thus tend to close out their long positions,12

leading to a potential increase in market liquidity.

In the previous literature, when using the moving average indicator, Kavajecz and

Odders-White (2004) found that when the long-run moving average is higher than the

short-run moving average, the extreme selling pressure which triggers a negative

moving average signal causes the quotes to walk down the book; thus, there will be an

increase (reduction) in sell-side (buy-side) depth. According to institutional and

individual investor expectations, we therefore examine whether sentiment has effects

on market liquidity and net buying volume when investors are more fearful of the

future returns on the underlying assets in either the bullish or bearish states.

4.4.1 The Interaction between Shorter-term and Medium-term (Institutional

Investor) Expectations

We now examine whether investors could close out their existing long positions or

hold their positions to affect market liquidity when investors are more fearful of the

future returns on the underlying assets in institutional bullish and bearish states. The

empirical regression and variables are as follows:

4
SPt     1 SPt -1   2 LogVt   3 Ret t  ∑ 4i DtWK 
i 1
, (7a)
 5 PCR t   6 (VIX / VXN ) t  D Inst   7 (VIX / VXN ) t  (1  D Inst )   t
4
SPt     1 SPt -1   2 LogVt   3 Ret t  ∑ 4i DtWK 
i 1
, (7b)
 5 (VIX / VXN ) t   6 PCR t  D Inst   7 PCR t  (1  D Inst )   t
Inst Inst
when the VIX/VXN × D and PCR × D are higher, investors have greater fear for

the future returns on the underlying assets in an institutional bearish state, and vice

versa.

Models 1 and 2 of Table 6 examine whether market liquidity could be influenced

12
See Pring (1995) and Whaley (2000).
20
when investors are more fearful of the future returns on the underlying assets in the
Inst
institutional bullish and bearish states. Those results for the VIX/VXN × D indicator,

which are positive in all of the samples, are also significant in SPY, two NYSE stocks,
Inst
and AAPL. In addition, PCR × D has a positive impact on market liquidity in

QQQQ and AAPL. These results indicate that when institutional investors already

expect the stock market to be lower in the future, if investors further exhibit fear

(exuberance) in regard to the future returns in the stock market, they would reduce

(increase) their trading within the market in the shorter-term period. The results are

similar to Hammed et al. (2009) who found that when the stock price lasts for up to

two weeks in large down markets, it tends to be higher in periods of high liquidity

commonality.
Inst
However, we have also found that the relationship between PCR × (1– D ) and

market spread is significantly negative for GE and PFE, and there is no significantly
Inst
positive relationship based on VIX/VXN × (1– D ). This result is interesting and

indicates that when institutional investors have bullish expectations of future market

movements, if investors are fearful of the future returns of the stock market, the market

liquidity would increase. Such findings are similar to those of Kavajecz and

Odders-White (2004).

<Table 6 is inserted about here>

We further investigate whether the causal trading behavior leading to the negative

relationship between interaction term of shorter-term and medium-term sentiments and

market spread. The new model and variables are as follows:

5 5 5
OIBNUM t    ∑ 1i OIBNUM t - j  ∑ 2i Max(0, Ret tj )  ∑ 3i Min (0, Ret tj )   4 LogVt 
j 1 j 1 j 1 , (8a)
4

∑ 5i DtWK   6 PCR t   7 (VIX / VNX ) t  D Inst   8 (VIX / VNX ) t  (1  D Inst )   t

i 1

21
 5 5 5
OIBNUM t    ∑ 1i OIBNUM t - j  ∑ 2i Max(0, Ret tj )  ∑ 3i Min (0, Ret tj )   4 LogVt 
j 1 j 1 j 1 , (8b)
4

∑ 5i DtWK   6 (VIX / VNX ) t   7 PCR t  D Inst   8 PCR t  (1  D Inst )   t

i 1

Inst Inst
where the VIX/VXN × D and PCR × D are the same as in Equations (7a) and (7b).
Inst
As shown in Models 3 and 4 of Table 6, the relationship between VIX/VXN × D and

net buying volume is significantly negative for SPY. The relationship between net
Inst
buying volume and PCR × D has no negative significance for SPY, GE, and MSFT.
Inst
We also find that the relationship between PCR × (1– D ) and net buying volume is

significantly negative in all the ETFs and individual stocks with the exception of

AAPL. Our results find that the net buying volume decrease when institutional

investors expect that the stock market will be higher in the future with unexpected

information leading to an increase in investor fear sentiment. Since investors have very

limited capacity for arbitrage, they are also likely to be extremely risk averse, and

short selling in individual stocks could be more costly under such circumstance,

investors would be unwilling to bear the short-term excess risk and thus choose to sell

stocks.

Specifically, for GE and PFE, we find that investors would be more likely to close

out their existing long positions during a bullish period in the market than in a bearish
Inst
period, and PCR ×(1– D ) has an impact on net buying volume that is less negatively

significant than the Table 3 coefficient. In addition, the relationship between PCR ×(1–
Inst
D ) and market spread is significantly negative in Models 1 and 2 of Table 6. Since

institutional investors expect the stock market to be higher in the future, this will lead

to an increase in net buying volume; if investors exhibit fear in regard to the future

returns in the stock market, this could lead to an increase in the sell orders, and thereby

causing order imbalance and market spread to reduce. These results help to provide an

understanding of the results reported in Models 1 and 2 of Table 6, and why the
22
 Inst
relationship between PCR × (1– D ) and market spread is significantly negative in

GE and PFE.

4.4.2 The Interaction between Shorter-term and Medium-term (Individual

Investor) Expectations

Finally, we examine whether or not investors, when they are more fearful of the

future returns on the underlying assets in their individual bullish and bearish states,

could close out their existing long positions to affect market liquidity. The empirical

regression and variables are as follows:

4
SPt     1 SPt -1   2 LogVt   3 Ret t  ∑ 4i DtWK 
i 1
, (9a)
 5 PCR t   6 (VIX / VXN ) t  D Ind   7 (VIX / VXN ) t  (1  D Ind )   t
4
SPt     1 SPt -1   2 LogVt   3 Ret t  ∑ 4i DtWK 
i 1
, (9b)
 5 (VIX / VXN ) t   6 PCR t  D Ind   7 PCR t  (1  D Ind )   t
Ind Ind
when the VIX/VXN × D and PCR × D are higher, investors have a greater fear of

the future returns on the underlying assets in an individual bearish state and vice versa.

Models 1 and 2 of Table 7 show that all of the relationships between VIX/VXN ×
Ind
D and the spread are significantly positive for SPY, PFE, and QQQQ, whereas
Ind
VIX/VXN × (1– D ) is barely significantly positive for SPY and AAPL. Regarding the

PCR sentiment indicators in the bullish and bearish states, we find that a significantly
Ind
positive relationship exists between PCR × D and market spread except for AAPL.
Ind
We also find a significantly positive relationship between PCR × (1-D ) and the

market spread for all the ETFs and individual stocks with the exception of SPY and

GE. In our ETFs results, we find that market spread becomes larger for individual

investors in the bearish state than in bullish state when unexpected information leads to

an increase in investor fear sentiment. We then examine the type of trading behavior

which gives rise to these results by examining how the interaction between

23
shorter-term and individual investor expectations affects the net buying volume. The

new model and variables are as follows:

5 5 5

OIBNUM t = α + ∑β1iOIBNUM t - j + ∑β2i Max(0, Ret tj ) + ∑β3i Min (0, Ret tj ) + β4 LogVt +
j =1 j =1 j =1 , (10a)
4

∑β 5i DtWK + β6 PCRt + β7 (VIX / VNX )t × D Ind + β8 (VIX / VNX )t × (1 D Ind ) + εt

i =1

5 5 5
OIBNUM t    ∑ 1i OIBNUM t - j  ∑ 2i Max(0, Ret tj )  ∑ 3i Min (0, Ret tj )   4 LogVt 
j 1 j 1 j 1 , (10b)
4

∑ 5i DtWK   6 (VIX / VNX ) t   7 PCR t  D Ind   8 PCR t  (1  D Ind )   t

i 1

Ind Ind
where the VIX/VXN × D and PCR × D are the same as in Equations (9a) and (9b).

As shown in Models 3 and 4 of Table 7, a significantly negative relationship is found

Ind
to exist between VIX/VXN × (1– D ) and net buying volume for SPY, GE, and QQQQ;
Ind
furthermore, the relationships between net buying volume and PCR × (1– D )

indicators are all negatively significant in all the ETFs and individual stocks.

<Table 7 is inserted about here>

Further observing Table 7, we see that a significantly negative relationship is

Ind
found between VIX/VXN × D and net buying volume for SPY and GE, with no

significance in this relationship for the samples listed on the NASDAQ. In addition,
Ind
the relationships between net buying volume and the PCR × D indicators are all

negatively significant except for AAPL. These results are similar with the findings in

Table 6. Our results also indicate that individual investors being fearful of the future

returns on the stock market would potentially lead to a decrease in net buying volume

that is more negatively significant than institutional investors and the Table 3

coefficient, thereby causing order imbalance and market spread to increase. Since

individual investors have more pessimistic (optimistic) sentiment than institutional

investors (Schmeling, 2007), and individual investors exhibit myopic loss aversion13

13
Benartzi and Thaler (1995) combined two behavioral concepts, loss aversion and mental accounting,
to provide a theoretical foundation for the observed equity premium puzzle. They find that investors
24
(Bernartzi and Thaler, 1995; Gneezy, Kapteyn and Potters, 2003), when investors are

more fearful of the future market movements, the trading behavior of individual

investors is more sensitive than institutional investors.

5. CONCLUSIONS
This study distinguishes between the „bearish versus bullish‟ and „fear versus

exuberance‟ sentiments and examines how these two types of sentiment affect market

liquidity and net buying volume. We find that that when investor sentiment becomes

more bullish, there is a reduction in market spread and an increase in buy orders. This

result provides support for the findings of Baker and Stein (2004) and Deuskar (2005).

Our results further show that when investors are more fearful of the future returns of the

underlying assets, investors will tend to hold on to their long positions or reduce their

trading activity. In other words, the investors decrease their buy orders in the market and

thereby leading to a reduction in market liquidity. Our results could help to explain the

Gito (2005) results.

We also find that there are systematic differences between bearish and bullish

sentiment in individual stocks for market liquidity and net buying volume.

Furthermore, the institutional investor sentiment indicator (II) affects market liquidity

more significantly than the individual investor sentiment indicator (AAII). These results

are similar to the Schmeling (2007) hypothesis that the sentiment of individuals has a

different effect than the sentiment of institutions. Regarding the comparison between

individual stocks and ETFs, when investors have more bearish sentiment, the reduction

in market liquidity could be greater for individual stocks than for ETFs; thus, any

reduction in net buying volume for individual stocks will be less than that for ETFs.

Such findings are more significant in the case of institutional investors, since all of our

seem to be more concerned with the potential for a short term loss than in planning for the relevant time
horizon and accepting periodic short-term losses.
25
sentiment indicators reflect the aggregate sentiment of market participants. In addition,

the previous results may also due to that individual stocks involve more trading costs

than ETFs do, and their market depth is also less than that of ETFs.

In terms of interaction sentiment, we find that when investors expect the stock

market to go down in the future with some unexpected information increasing investor

fear sentiment leading to a reduction in net buying volume and a corresponding

reduction in market liquidity. Our results are similar to those of Hammed et al. (2009)

in that the stock price remains stable for up to two weeks in large down markets and is

higher in periods of high liquidity commonality. Secondly, we also discover that when

investors are fearful of the future returns on the underlying assets in an institutional

bullish state, there will be a more significant reduction in net buying volume than

normal, causing an increase in the market liquidity of individual stocks. These findings

would appear to indicate that investors will tend to close out their long positions under

such circumstances. In addition, our results are consistent with those of Kavajecz and

Odders-White (2004) in that when the long-run moving average is higher than the

short-run moving average; selling pressure would increase in the market, which will

also increase sell-side market depth. Finally, in terms of the interaction between

shorter-term and individual investor expectations, we find that, for individual investors,

the reduction in market liquidity in the bearish state is more sensitive than that in

bullish state for the ETFs when unexpected information leads to an improvement in

investor fear sentiment. Furthermore, the trading behavior of individual investors is

more sensitive than institutional investors when investors are more fearful of the future

market movements. Overall, the findings obtained from our exploration of the

relationship between investor sentiment and net buying volume help to provide a better

understanding of the relationship between investor sentiment and market liquidity.

26
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Solt, M. E. and M. Statman (1988), „How Useful is the Sentiment Index?‟, Financial

Analysts Journal, 44: 45–55.

Vlad, D.G. (2004), „Investors‟ Beliefs and their Implications on Asset Pricing, Excess

Returns and Volatilities in Financial Markets‟, Ph.D. Thesis, Southern Illinois

University.

Wang, Y.H., A. Keswani and S.J. Taylor (2006), „The Relationships between Sentiment,

Returns and Volatility‟, International Journal of Forecasting, 22: 109-123.

Whaley, R.E. (2000), „The Investor Fear Gauge‟, Journal of Portfolio Management, 26:

12-17.

31
Table 1a Descriptive Statistics of the Dependent and Control Variables

Ticker Symbols
Variables
SPY GE PFE QQQQ AAPL MSFT
Ret
Mean 0.0000 –0.0001 –0.0004 –0.0001 –0.0003 0.0001
Median 0.0006 –0.0004 –0.0004 0.0010 –0.0005 0.0000
S.D. 0.0107 0.0167 0.0161 0.0183 0.0163 0.0174
LogV
Mean 17.6084 16.9462 16.8724 18.3113 16.9092 17.9718
Median 17.6638 16.8973 16.8547 18.3118 16.9138 17.9587
S.D. 0.7894 0.3942 0.5106 0.3633 0.5344 0.3600
SPREAD
Mean 0.0466 0.1676 0.2324 0.0793 0.0683 0.0386
Median 0.0233 0.1187 0.1187 0.0444 0.0491 0.0389
S.D. 0.0483 0.1569 0.1997 0.0757 0.0483 0.0087
OIBNUM
Mean 0.5787 4.9946 0.3036 0.3485 0.6433 -0.3049
Median 0.2875 3.8210 2.0585 0.2730 0.4961 -0.1353
S.D. 5.7139 9.5468 13.7885 3.1918 2.2121 1.9433

Note: The descriptive statistics are provided for the dependent and control variables, comprising of Ret, LogV,
SPREAD and OIBNUM. The data covers the period from 29 January 2001 to 31 December 2007 for GE,
PFE, SPY and QQQQ, from 26 March 2001 to 31 December 2007 for AAPL, and from 9 April 2001 to 31
December 2007 for MSFT.

Table 1b Descriptive Statistics of the Sentiment-Related Variables

Variables Mean Median S.D.

Implied Volatility
VIX 19.0337 17.3400 7.0941
VXN 28.4717 21.3700 14.7387
Market Sentiment
VIXSENT –0.0030 –0.9102 4.4678
VXNSENT 0.5682 –0.7545 5.1415
Put-Call Ratio 0.6789 0.6600 0.1396
Direct Sentiment
Individual 0.7820 0.6874 0.4481
Institutional 0.5729 0.5399 0.2011

Note: The descriptive statistics are provided for the sentiment-related variables, comprising of VIX, VXN,
VIXSENT, VXNSENT and Put-Call Ratio. The data covers the period from 29 January 2001 to 31
December 2007 for GE, PFE, SPY and QQQQ, from 26 March 2001 to 31 December 2007 for AAPL, and
from 9 April 2001 to 31 December 2007 for MSFT.

32
Table 2 Investor Sentiment and Market Liquidity

NYSE NASDAQ
Variables SPY-VIX GE-VIX PFE-VIX QQQQ-VXN AAPL-VXN MSFT-VXN
Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value
Panel A: Bearish versus Bullish
Institutional 0.0054 3.014*** 0.0611 5.214*** 0.0572 4.277*** 0.0085 2.720*** 0.0456 2.051** –0.0006 –0.819
Individual 0.0011 1.326 –0.0065 –1.291 –0.0063 –1.067 –0.0001 –0.131 0.0044 0.461 0.0004 1.972**
SPt – 1 0.9245 94.582*** 0.8171 59.219*** 0.8193 58.400*** 0.9421 117.706*** 0.9093 82.889*** 0.9191 98.536***
LogV –0.0029 –5.054*** 0.0038 –0.735 –0.0253 –4.677*** –0.0037 –2.305** -0.0044 –4.567*** 0.0000 0.158
Ret –0.0934 –3.397*** –0.6774 –5.625*** –0.7278 –5.005*** –0.1481 –5.169*** –0.0749 –2.840*** –0.0038 –6.225***
C 0.0509 5.004*** –0.0628 –0.708 0.4383 4.723*** 0.0068 2.300** 0.0801 4.672*** 0.0003 6.062***
Observations 1740 1740 1740 1740 1449 1439
2
R 0.9370 0.7215 0.7642 0.9181 0.8893 0.852

Panel B: Fear versus Exuberance

VIX/VXNSENT 0.0003 4.050*** 0.0007 1.453 0.0014 2.497** 0.0002 1.795* 0.0020 2.507** 0.0000 0.037
Put-Call Ratio 0.0034 1.563 0.1277 8.414*** 0.0553 3.067*** 0.0085 2.131** 0.0062 1.721* 0.0022 2.999***
SPt – 1 0.9164 89.349*** 0.7940 57.238*** 0.8145 57.147*** 0.9420 119.142*** 0.8986 78.774*** 0.8390 59.701***
LogV –0.0037 –5.767*** –0.0004 –0.026 –0.0283 –5.236*** –0.0049 –2.825*** –0.0052 –5.105*** –0.0004 –1.354
Ret –0.0571 –1.992** –0.3794 –3.123*** –0.5917 –4.025*** –0.1203 –4.052*** –0.0637 –2.395** –0.0390 –5.714***
C 0.0667 5.637*** –0.0503 –0.531 0.4791 5.035*** 0.0881 2.753*** 0.0931 5.020*** 0.0128 2.014**
Observations 1740 1740 1740 1740 1449 1439
2
R 0.9373 0.7298 0.7645 0.9181 0.8901 0.7420

Note: The dependent variable is the daily percentage spread on trading day t, which is regressed on lagged market liquidity, LogV, the return on day t, day-of-the-week dummies, direct
sentiment (Individual and Institutional), and market sentiment (VIX, VXN and Put-Call Ratio). ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively.

33
Table 3 Investor Sentiment and Net Buying Volume

NYSE NASDAQ
Variables SPY-VIX GE-VIX PFE-VIX QQQQ-VXN AAPL-VXN MSFT-VXN
Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value
Panel A: Bearish versus Bullish
Institutional –2.883 –3.172*** 2.036 1.199 2.168 1.197 –0.370 –0.770 0.299 0.877 0.225 0.766
Individual –0.010 –0.003 –1.807 –3.212*** –1.328 –2.116** –0.228 –1.133 0.005 0.034 –0.101 –0.801
LogV –0.059 –0.319 –1.429 –2.377** –1.888 –3.370*** –0.016 –0.073 –0.022 –0.191 0.259 1.795*
C 2.851 0.858 26.271 2.576*** 31.155 3.272*** 1.311 0.322 0.349 0.178 –5.025 –1.954*
Observations 1740 1740 1740 1740 1449 1439
2
R 0.025 0.138 0.478 0.046 0.049 0.135
Panel B: Fear versus Exuberance
VIX/VXNSENT –0.271 –6.304*** –0.192 –3.307*** –0.008 –0.136 –0.044 –2.384** 0.002 0.157 0.013 1.158
Put-Call Ratio –2.729 –2.608*** –8.088 –5.012*** –5.482 –3.488*** –1.294 –2.276** –0.709 –1.471 –0.932 –3.145***
LogV 0.424 2.222** –1.268 –2.045** –1.613 –2.863*** 0.189 0.787 0.047 0.398 0.227 1.551
C –6.215 –1.729* 27.484 2.553** 31.491 3.402*** –2.115 –0.474 0.279 0.144 –3.534 –1.331
Observations 1740 1740 1740 1740 1449 1439
2
R 0.046 0.154 0.481 0.051 0.049 0.141

Note: The dependent variable is the daily percentage standardized net buying volume on trading day t, which is regressed on lagged percentage standardized net buying volume and past
positive and negative elements of the market return on day t, LogV, day-of-the-week dummies, direct sentiment (Individual and Institutional), and market sentiment (VIX, VXN and
Put-Call Ratio). The individual parts of the dependent variable results are not reported here in order to space; however, they are available upon request. ***, **, and * indicate
significance at the 1%, 5%, and 10% levels, respectively.

34
 Table 4 Bearish and Bullish Sentiment and Market Liquidity

NYSE NASDAQ
Variables SPY-VIX GE-VIX PFE-VIX QQQQ-VXN AAPL-VXN MSFT-VXN
Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value
Panel A: Institutional
Inst
Institutional × D 0.0057 3.104*** 0.0376 5.089*** 0.0599 4.305*** 0.0001 2.856*** 0.0061 2.581*** –0.0007 –1.221
Inst
Institutional × (1 – D ) 0.0068 3.535*** 0.0048 3.675*** 0.0400 2.735*** 0.0007 2.208** 0.0020 0.745 –0.0008 –1.161
SPt – 1 0.9260 95.220*** 0.8168 59.133*** 0.8176 57.877*** 0.9421 118.239*** 0.9060 81.354*** 0.8482 61.876***
LogV –0.0027 –4.830*** 0.0024 0.257 –0.0276 –5.188*** 0.0003 –2.424** –0.0048 –4.814*** –0.0003 –1.108
Ret –0.0977 –3.572*** –0.6444 –5.511*** –0.7268 –4.989*** –0.0015 –5.176*** –0.0768 –2.912*** –0.0430 –6.321***
C 0.0463 4.719*** –0.0166 –0.204 0.4820 5.205*** 0.0694 2.421** 0.0879 4.952*** 0.0132 2.143**
Observations 1740 1740 1740 1740 1449 1439
2
R 0.9371 0.7193 0.7642 0.9181 0.8894 0.7405
F-test 0.4487 4.9408*** 2.0371* 0.2784 2.8118** 0.008
Panel B: Individual
Ind
Individual × D 0.0017 2.067** –0.0023 –0.429 0.0008 0.142 0.0001 0.815 –0.0007 –0.626 0.0005 1.686*
Ind
Individual × (1 – D ) 0.0011 0.681 –0.0172 –1.425 –0.0065 –0.521 0.0005 0.116 –0.0009 –0.396 0.0009 1.486
SPt – 1 0.9368 105.275*** 0.8408 64.842*** 0.8358 61.802*** 0.9508 130.005*** 0.9132 84.317*** 0.8498 63.010***
LogV –0.0026 –4.485*** 0.0061 1.162 –0.0265 –4.908*** –0.0003 –2.116** –0.0045 –4.564*** –0.0005 –1.609
Ret –0.0848 –3.089*** –0.6228 –5.151*** –0.6856 –4.672*** –0.0014 –4.946*** –0.0712 –2.703*** –0.0432 –6.418***
C 0.0474 4.650*** –0.0701 –0.784 0.4844 5.288*** 0.0653 2.223** 0.0842 4.935*** 0.0148 2.465**
Observations 1740 1740 1740 1740 1449 1439
2
R 0.9367 0.7179 0.7619 0.9177 0.8890 0.7407
F-test 0.3427 4.4062*** 0.7692 0.1931 0.0147 0.9226

Note: The dependent variable is the daily percentage spread on trading day t, which is regressed on lagged market liquidity, LogV, the return on day t, and day of the week dummies. The dummy
variable DInd is equal to 1 on days when the AAII indicator is equal to or greater than 1, and DInst is equal to 1 on days when the II indicator is equal to or greater than 1. Therefore,
Individual × DInd and Institutional × DInst indicate that individual and institutional investors expect future market moments to be bearish rather than bullish, and vice versa. Parts of the
estimated results are not reported here in order to save space; however, they are available upon request. The F-test examines whether the Institutional × DInst is equal to Institutional × (1–
DInst) in Panel A, and whether the Individual × DInd is equal to Individual × (1– DInd) in Panel B. ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively.

35
Table 5 Bearish and Bullish Sentiment and Net Buying Volume

NYSE NASDAQ
Variables SPY-VIX GE-VIX PFE-VIX QQQQ-VXN AAPL-VXN MSFT-VXN
Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value
Panel A: Institutional
Institutional × DInd –2.839 –2.921*** –0.351 –0.291 1.978 1.318 –0.471 –0.979 0.292 0.848 0.015 0.005
Institutional × (1– DInd) –2.919 –3.142*** –1.339 –1.141 –0.206 –0.134 –0.736 –1.427 0.320 0.847 0.403 1.130
LogV –0.061 –0.350 –1.689 –2.825*** –2.193 –3.932*** –0.086 –0.399 –0.019 –0.175 0.278 1.917*
C 2.902 0.910 30.669 3.005*** 36.657 3.831*** 2.586 0.654 0.302 0.154 –5.541 –2.128**
Observations 1740 1740 1740 1740 1449 1439
2
R 0.025 0.134 0.477 0.045 0.049 0.136
F-test 0.009 0.363 2.222* 0.355 0.007 2.154*
Panel B: Individual
Individual × DInd –0.598 –1.685* –1.495 –2.576*** –1.667 –2.594*** –0.314 –1.725* –0.023 –0.145 –0.148 –1.112
Individual × (1– DInd) –0.885 –1.652* –1.513 –1.324 –3.461 –2.687*** –0.302 –0.754 –0.133 –0.421 –0.382 –1.472
LogV 0.057 0.305 –1.451 –2.402** –1.938 –3.514*** –0.008 –0.037 –0.011 –0.092 0.253 1.753*
C 0.185 0.057 27.246 2.672*** 33.990 3.682*** 1.071 0.264 0.381 0.205 –4.675 –1.815*
Observations 1740 1740 1740 1740 1449 1439
2
R 0.020 0.137 0.479 0.046 0.052 0.136
F-test 0.342 0.001 4.314*** 0.002 0.287 1.914

Note: The dependent variable is the daily percentage standardized net buying volume on trading day t, which is regressed on lagged percentage standardized net buying volume and past
positive and negative elements of the market return on day t, LogV, and day of the week dummies. The dummy variable DInd is equal to 1 on days when the AAII indicator is equal to or
greater than 1, and DInst is equal to 1 on days when the II indicator is equal to or greater than 1. Therefore, Individual × DInd and Institutional × DInst indicate that individual and
institutional investors expect future market moments to be bearish rather than bullish, and vice versa. Parts of the estimated results are not reported here in order to save space; however,
they are available upon request. The F-test examines whether the Institutional × DInst is equal to Institutional × (1– DInst) in Panel A, and whether the Individual × DInd is equal to
Individual × (1– DInd) in Panel B. ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively

36
Table 6 Interaction between Shorter-term and Medium-term (Institutional Investor) Expectations

Model 1 Model 2 Model 3 Model 4

Variables (market liquidity) (market liquidity) (net buying volume) (net buying volume)
Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value
Panel A: NYSE
1. SPY-VIX
Put-Call Ratio 0.0041 1.845** –2.998 –3.44***
VIX/VXN 0.0003 3.638*** –0.265 –6.027***
VIX/VXN × D Inst
0.0005 3.400*** –0.212 –2.697***
VIX/VXN × (1 – D ) Inst
0.0001 1.294 –0.004 –1.288
Put-Call Ratio × D Inst
0.0044 1.461 –3.427 –2.307**
Put-Call Ratio × (1 – DInst ) 0.0034 1.517 –2.729 –2.598***
2
R 0.937 0.937 0.028 0.042

2. GE-VIX
Put-Call Ratio –0.0143 –1.127 –0.213 –5.378***
VIX/VXN 0.0014 2.518** –0.130 –2.042**
VIX/VXN × DInst 0.0004 4.234*** –0.135 –1.095
VIX/VXN × (1 – D ) Inst –0.0000 –1.403 –0.003 –0.605
Put-Call Ratio × D Inst
0.0147 0.728 –6.518 –3.057***
Put-Call Ratio × (1 – D Inst
) –0.0326 –2.477** –6.544 –4.670***
2
R 0.733 0.722 0.151 0.153
3. PFE-VIX
Put-Call Ratio 0.0621 3.489*** –6.944 –3.869***
VIX/VXN 0.0026 3.737*** –0.038 –0.575
Inst
VIX/VXN × D 0.0042 3.518*** 0.067 0.522
VIX/VXN × (1 – D ) Inst –0.0001 –1.366 –0.003 –0.550
Put-Call Ratio × D Inst –0.0320 –1.359 –3.082 –1.268
Put-Call Ratio × (1 – D Inst
) –0.0705 –4.594*** –5.413 –3.443***
2
R 0.766 0.767 0.481 0.481

Note: The dependent variable is the daily percentage spread on trading day t in Models 1 and 2; the independent variables include lagged
market liquidity, LogV, the return on day t, day-of-the-week dummies, the put-call ratio, and VIX/VXN. Dependent variables in
Models 3 and 4 are the daily percentage standardized net buying volumes on trading day t, They are regressed on lagged percentage
standardized net buying volume and past positive and negative components of the market return on day t, LogV, day-of-the-week
dummies, and the put-call ratio. The dummy variable DInst is equal to one on days when the II indicator is greater than or equal to
one., Therefore, a higher (lower) VIX/VXN × DInst, PCR × DInst, VIX/VXN × DInst, or PCR × DInst indicates more (less) fear amongst
investors regarding the future returns on the underlying asset in a bearish state. Parts of the estimated results are not reported here in
order to save space; however, they are available upon request. ***, **, and * indicate significance at the 1%, 5%, and 10% levels,
respectively.

37
Table 6 (Contd.)

Model 1 Model 2 Model 3 Model 4

Variables (market liquidity) (market liquidity) (net buying volume) (net buying volume)
Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value
Panel B: NASDAQ
1. QQQQ-VXN
Put-Call Ratio 0.0091 2.300** –1.503 –2.642***
VIX/VXN 0.0002 1.328 –0.265 –6.027***
Inst
VIX/VXN × D 0.0003 1.260 0.020 0.536
VIX/VXN × (1 – D ) Inst
0.0000 –0.290 0.000 –0.274
Put-Call Ratio × DInst 0.0130 2.471** –1.041 –1.386
Put-Call Ratio × (1 – D Inst
) 0.0079 1.994** –1.326 –2.318**
2
R 0.918 0.918 0.048 0.051

2. AAPL-VXN
Put-Call Ratio 0.0083 2.417** –0.621 –1.354
VIX/VXN 0.0002 2.308** –0.002 –0.146
Inst
VIX/VXN × D 0.0004 2.460** 0.016 0.587
VIX/VXN × (1 – D ) Inst –0.0001 –0.451 –0.001 –1.353
Put-Call Ratio × D Inst
0.0081 1.875* –0.126 –0.219
Put-Call Ratio × (1 – D Inst
) 0.0031 0.906 –0.028 –0.661
2
R 0.890 0.890 0.054 0.049
3. MSFT-VXN
Put-Call Ratio 0.0024 3.379*** –1.288 –1.611
VIX/VXN 0.0001 0.445 0.017 1.442
VIX/VXN × DInst –0.0001 –0.789 5.349 0.114
VIX/VXN × (1 – D ) Inst –0.0004 –1.079 –1.049 0.539
Put-Call Ratio × D Inst
0.0013 1.256 –1.456 –3.369***
Put-Call Ratio × (1 – D Inst
) 0.0020 2.850** –0.936 –3.238***
2
R 0.7423 0.7419 0.137 0.143

38
Table 7 Interaction between Shorter-term and Medium-term (Individual Investor) Expectations

Model 1 Model 2 Model 3 Model 4

Variables (market liquidity) (market liquidity) ((net buying volume) (net buying volume)
Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value
Panel A: NYSE
1. SPY-VIX
Put-Call Ratio 0.0026 1.164 –2.843 –2.694***
VIX/VXN 0.0003 3.422*** –0.289 –6.488***
VIX/VXN × D Ind
0.0005 4.207*** –0.233 –3.718***
VIX/VXN × (1 – D Ind
) 0.0002 2.158** –0.292 –5.884***
Put-Call Ratio × DInd 0.0038 1.735* –2.432 –2.286**
Put-Call Ratio × (1 – D Ind
) 0.0027 1.172 –3.135 –2.906***
2
R 0.9374 0.9373 0.046 0.047
2. GE-VIX
Put-Call Ratio 0.1273 8.236*** –8.179 –5.012***
VIX/VXN 0.0011 1.958** –0.169 –2.745***
VIX/VXN × DInd 0.0001 1.075 –0.168 –1.979**
VIX/VXN × (1 – D Ind
) 0.0007 1.046 –0.209 –2.830***
Put-Call Ratio × D Ind
0.0554 3.636*** –8.386 –5.115***
Put-Call Ratio × (1 – D Ind
) 0.0089 1.377 –7.649 –4.583***
2
R 0.7299 0.7215 0.154 0.155
3. PFE-VIX
Put-Call Ratio 0.0506 2.755*** –6.899 –3.733*** –60.031 –0.474
VIX/VXN 0.0017 2.708***
Ind
VIX/VXN × D 0.0023 2.664*** 0.008 0.092
VIX/VXN × (1 – D Ind
) 0.0007 0.934 –0.061 –0.772
Put-Call Ratio × DInd 0.0528 2.90*** –6.728 –3.645***
Put-Call Ratio × (1 – D Ind
) 0.0609 3.238*** –6.688 –3.550***
2
R 0.7648 0.7646 0.481 0.481

Note: The dependent variable is the daily percentage spread on trading day t in Models 1 and 2; the independent variables include
lagged market liquidity, LogV, the return on day t, day-of-the-week dummies, the put-call ratio, and VIX/VXN. Dependent
variables in Models 3 and 4 are the daily percentage standardized net buying volumes on trading day t, They are regressed on
lagged percentage standardized net buying volume and past positive and negative components of the market return on day t,
LogV, day-of-the-week dummies, and the put-call ratio. The dummy variable DInd is equal to one on days when the AAII
indicator is greater than or equal to one. Therefore, when VIX/VXN × DInd, PCR × DInd, VIX/VXN × DInd, or PCR × DInd is
higher, it means that investors are more fearful regarding the future return on the underlying assets in the bearish state, and
vice versa. Parts of the estimated results are not reported here in order to save space; however, they are available upon request.
***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively.

39
Table 7 (Contd.)

Model 1 Model 2 Model 3 Model 4

Variables (market liquidity) (market liquidity) (net buying volume) (net buying volume)
Coeff. t-Value Coeff. t-Value Coeff. t-Value Coeff. t-Value
Panel B: NASDAQ
1. QQQQ-VXN
Put-Call Ratio 0.0077 1.926* –1.479 –2.567**
VIX/VXN 0.0002 2.1397** –0.029 –1.5470
VIX/VXN × DInd 0.0003 1.956* –0.009 –0.350
VIX/VXN × (1 – DInd ) 0.0002 0.712 –0.071 –3.079***
Put-Call Ratio × DInd 0.0086 2.1397** –1.766 –3.456***
Put-Call Ratio × (1 – D Ind
) 0.0082 1.981** –1.641 –3.065***
2
R 0.918 0.918 0.053 0.055
2. AAPL-VXN
Put-Call Ratio 0.0065 1.792* –0.681 –1.405
VIX/VXN 0.0003 3.201*** –1.228 –2.344**
VIX/VXN × D Ind
0.0002 1.446 –0.005 –0.293
VIX/VXN × (1 – D Ind
) 0.0003 2.287** 0.009 0.519
Ind
Put-Call Ratio × D 0.0055 1.511 0.654 1.342
Put-Call Ratio × (1 – DInd ) 0.0089 2.376** –0.826 –1.656*
2
R 0.890 0.891 0.053 0.055
3. MSFT-VXN
Put-Call Ratio 0.0021 3.038*** –0.931 –3.145***
VIX/VXN 0.0000 0.142 0.011 0.910
VIX/VXN × D Ind
–0.0002 –0.757 0.007 0.414
VIX/VXN × (1 – DInd ) 0.0003 0.860 0.020 1.378
Put-Call Ratio × D Ind
0.0021 2.985*** –0.921 –3.106***
Put-Call Ratio × (1 – DInd ) 0.0023 2.947*** –1.040 –3.285***
2
R 0.742 0.742 0.141 0.142

40