Sentiment index

A recent paper at http://econpapers.repec.org is about a sentiment index based on stock recommendations by professional analysts published in the German print and online media. Sentiment based on printed analyst recommendations follows reversals; that is, when analysts face a stock market downturn, they see a buying opportunity and become optimistic, note Nico Singer, Frank Dreher and Saskia Laser in Published Stock Recommendations as Institutional Investor Sentiment in the Near-Term Stock Market.

For starters, a simple definition of ‘sentiment,' as given in the paper, is that “sentiment represents the expectations of market participants relative to a norm.” Considering that stock recommendations are made by professional financial analysts, the paper interprets this measure as professional investor sentiment. In contrast to earlier studies on the subject, the authors find that market sentiment turns optimistic after a decline in stock returns, that is, sentiment follows trend reversal instead of trend following. This result favours the bargain shopper hypothesis, that is, “when analysts see stocks becoming a bargain (for which a negative return serves as a proxy), they see a buying opportunity and become bullish,” reads a snatch, citing Brown and Cliff (2004). Makes a case for an objective treatment of a sentiment-al topic.

Pecking order

As applied to finance, the pecking order theory states that companies prioritise their sources of financing (from internal financing to equity) according to the principle of least effort, or of least resistance, preferring to raise equity as a financing means of last resort (http://en.wikipedia.org). “Hence, internal funds are used first, and when that is depleted, debt is issued, and when it is not sensible to issue any more debt, equity is issued.” A research paper by Saumitra Bhaduri of Madras School of Economics, titled Why Do Firms Issue Equity? Some evidence from an emerging economy, India, tests the hypothesis by studying a sample of 556 manufacturing firms over the period 1997-2007 (http://mpra.ub.uni-muenchen.de).

Indian firms prefer debt to equity even in a deregulated regime, which is consistent with the hypothesis, the author writes. “Equity financing for the Indian firm plays a minimal role, while bulk of the financing deficit is covered through debt.” These results, he points out, are in contrast to many studies — such as Fama and French (2005), Frank and Goyal (2003), Leary and Roberts (2004) — for a set of firms from the developed countries.

However, Bhaduri is not surprised, because weak regulatory framework in many developing countries does not facilitate effective information disclosures, and hence the relationships derived from information-based models (e.g. pecking order model) are more likely to have a better empirical validity here. Insightful work.

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