The Impact of Investor Sentiment on the German Stock Market

This paper investigates whether investor sentiment can explain stock returns on theGerman stock market. Based on a principal component analysis, we construct a senti-ment indicator that condenses information of several well-known sentiment proxies. Weshow that this indicator explains the return spread between sentiment stocks and stocksthat are not sensitive to sentiment °uctuations. Speci¯cally, stocks that are di±cult toarbitrage and hard to value are sensitive to the indicator. However, we do not ¯nd muchpredictive power of sentiment for future stock returns. This is consistent with sentimentbeing of minor importance on the German stock market that is characterized by a lowfraction of retail investors.