"Human behaviour flows from three main sources - desire, emotion and knowledge" is the famous and ever applicable saying by Plato.
The history of the stock market is full of events striking enough to earn their own names
In the United States : the Great Crash of 1929, the 'Tronics Boom of the early 1960s, the Go-Go Years of the late 1960s, the Nifty Fifty bubble of the early 1970s, and the Black Monday crash of October 1987 and the 2008 financial crisis.
In India: the Harshad Mehta crisis of 1992, the Y2K of 2000, Ketan Parikh crisis of 2001, 2008 financial crisis, and lately the NBFC crisis of 2018.
Each of these events refers to a dramatic level or change in stock prices that seems to defy explanation.
The standard finance model, where unemotional investors always force capital market prices equal to the rational present value of expected future cash flows, has considerably difficulty fitting these patterns.
Out of all of the above it might be pertinent to study Option implied volatility as it is being widely used and continously reported. Options prices rise when the value of the underlying asset has greater expected volatility.
(options pricing models such as the Black-Scholes formula can be inverted to yield implied volatility as a function of options prices.)
The Market Volatility Index (“VIX”), which measures the implied volatility of options on the Standard and Poor’s 100 stock index, is often called the “investor fear gauge” by practitioners.
Similarly the VIX of Nifty - National Stock Exchange (of India) Top 50 stocks index is widely available. This is the measure of "fear" in the Indian Stock Market.
In the United States : the Great Crash of 1929, the 'Tronics Boom of the early 1960s, the Go-Go Years of the late 1960s, the Nifty Fifty bubble of the early 1970s, and the Black Monday crash of October 1987 and the 2008 financial crisis.
In India: the Harshad Mehta crisis of 1992, the Y2K of 2000, Ketan Parikh crisis of 2001, 2008 financial crisis, and lately the NBFC crisis of 2018.
Each of these events refers to a dramatic level or change in stock prices that seems to defy explanation.
The standard finance model, where unemotional investors always force capital market prices equal to the rational present value of expected future cash flows, has considerably difficulty fitting these patterns.
Researchers in behavioral finance have been working to augment the standard model with an alternative model built on two basic assumptions.
- The first assumption is that investors are subject to sentiment.
- The second assumption is that betting against sentimental investors is costly and risky.
Now, the question is no longer, as it was a few decades ago, whether investor sentiment affects stock prices, but rather how to measure investor sentiment and quantify its effects.
( Some others are first-day returns on initial public offerings, volume of initial public offerings, new
Investor sentiment is not straightforward to measure, but so far some ways of measuring sentiment, in the context of investor psychology include :
- surveys,
- mood proxies,
- retail investor trades,
- mutual fund flows,
- trading volume,
- dividend premia,
- option implied volatility or (VIX)
( Some others are first-day returns on initial public offerings, volume of initial public offerings, new
equity issues, and insider trading)
Out of all of the above it might be pertinent to study Option implied volatility as it is being widely used and continously reported. Options prices rise when the value of the underlying asset has greater expected volatility.
(options pricing models such as the Black-Scholes formula can be inverted to yield implied volatility as a function of options prices.)
The Market Volatility Index (“VIX”), which measures the implied volatility of options on the Standard and Poor’s 100 stock index, is often called the “investor fear gauge” by practitioners.
Similarly the VIX of Nifty - National Stock Exchange (of India) Top 50 stocks index is widely available. This is the measure of "fear" in the Indian Stock Market.
NSE India VIX Graph (from July 23, 2010 to Feb 1, 2019)
Source : www.nseindia.com
While this much help is available from statistics the rest - Greed and irrational exuberances is best measured or judged by getting the pulse of the market from various "sources" be it surveys, or mood proxies, retail investor trades etc. etc. and it's in these small measures lies the devil and the fun.
(Disclaimer : Equity investing is a with risk investing and please make yourself aware and understand all possible risks before investing in equities. This includes the risk of loss of capital)
