Threshold effect in the relationship between investor sentiment and stock market returns: a PSTR specification

Investors Sentiment about the future of capital markets can play an effective role on the market price trend and stock return and refer to the views of investors about the future of the capital market. This paper investigates the threshold effects of Investors Sentiment on stock return of firms listed in Tehran Stock Exchange for the period of 15 Years (2005-2019), with construct Investors’ Sentimen index, using Panel Smooth Transition Regression (PSTR) model. The linearity test results indicate strongly nonlinear relationship among variables under consideration. Moreover, considering one transition function and one threshold parameter, as a two regime model, is sufficient to specification of nonlinear and threshold relationship among variables.The results indicate that threshold value for this firms is 71.34 and the estimated slope parameter is 0.32. The findings of this study indicate that in the first regime, investor sentiment effect is positively activated, increasing stock returns; however when their overconfidence sentiment exceeds some threshold, this effect becomes inverse in the secend regime for a high threshold level of market confidence and investor over-optimism.