The role of uncertainty and sentiment in market efficiency

This study examines the dynamic relationship between market efficiency, investor sentiment, and economic uncertainty in the U.S. stock market. Using the degree of multifractality derived from Multifractal Detrended Fluctuation Analysis as a proxy for market inefficiency, we analyze its interaction with multiple sentiment and uncertainty measures within an econometric framework. The results reveal long-run cointegration relationships between market inefficiency and the sentiment proxies Bearish, Bullish, and SENT, while no cointegration is found with the uncertainty proxies. Vector Error Correction Model estimates show that for all cointegrated sentiment pairs, market inefficiency is weakly exogenous, with the adjustment toward the long-run equilibrium operating through the sentiment variables themselves. In the short run, heightened pessimistic sentiment Granger-causes increases in inefficiency. Uncertainty influences market inefficiency primarily through short-run dynamics, with FUI and MUI exhibiting bidirectional Granger causality with inefficiency. Overall, the findings suggest that sentiment maintains a structural long-run relationship with market inefficiency, while uncertainty operates predominantly through short-term channels. These results offer nuanced insights into the distinct temporal roles of sentiment and uncertainty, with implications for risk management and resource allocation.