Defining and measuring market sentiments: a review of the literature

Purpose The purpose of this paper is to review and discuss the literature focusing on defining and measuring sentiments so as to understand their role in stock market behavior. Design/methodology/approach Critical review of the literature by analyzing myriad scholarly articles. The study is based on an analysis of 81 scholarly articles to critically analyze the approach toward defining and measuring market sentiments. The articles have been examined to identify and critique different classification of sentiment measures. A discussion is built to scrutinize the sentiment measures under the purview of theoretical underpinnings of the investor sentiment theory as well. Findings With more than five decades of research, the sentiment construct in finance literature is still ill-defined. Myriad empirical proxies of sentiment measures have led to conflicting results. The sentiment construct defined in financial theories needs to be revisited from the lens of sentiments defined in psychology. Research limitations/implications The study is limited to analyzing the role of individual and institutional sentiments in equity markets. There is a need to explore sentiments with respect to different investment styles and strategies along with the type of investors. Practical implications Developing a suitable sentiment proxy can result in devising profitable trading strategies for investors. Understanding factors driving investor sentiments will help regulators to become more proactive and frame better policies. Originality/value This paper has leveraged psychology literature to highlight the limitations in development of sentiment construct in finance literature. By identifying stylized facts from reviewing the empirical literature, it highlights areas for future research.