A dynamic factor model applied to investor sentiment in the European context

This paper proposes an Investor Sentiment Index for the European market and tests its predictability power over returns volatility. The constructed Europe draws upon three well-established two recent individual sentiment proxies through a novel dynamic factor modeling addressed to behavioral finance. index is obtained extended period of analysis validated with other measures. work relies on based model it using TGARCH volatility returns. It carries out in-sample out-of-sample examine this index’s forecasting sustained recursive rolling window prediction against Fama French’s three-factor model. findings demonstrate that proposed closely predicts STOXX600 variance confirms strong spillover effect between US stock markets. study also concludes valid alternative method investors monitor predict behaviors. developed measure vital movement tool financial information providers, investors, bankers, analysts. research combines approach validates An predictive work’s compared AcknowledgmentThis funded by National Funds FCT – Foundation Science Technology, I.P., within scope project Refª UIDB/05583/2020. Furthermore, we would like thank Research Centre in Digital Services (CISeD) Polytechnic Viseu their support.