The impact of investor sentiment on returns and conditional volatility in U.S. futures markets

In this paper, we use data from the DCOT report to test the usefulness of trader-position based sentiment in explaining returns and volatility in 13 major futures markets. Our main findings are that shifts in Producer/Merchant/Processor/User sentiment are positively related to price volatility in the majority of the tested markets and tend to destabilize these markets, while shifts in Money Manager sentiment tend to stabilize futures markets by reducing market volatility. We further investigate the relevance of behavioral finance and noise trader theory in futures markets by allowing for asymmetry in the variance equation of the used EGARCH model. We find that Producer/Merchant/Processor/User entities may behave like irrational investors and thus destabilize markets as they become bullish, while Money Managers may behave like rational traders and then tend to counterbalance price deviations from fundamental values caused by irrational trades. (C) 2016 Elsevier B.V. All rights reserved.