Investor sentiment and stock market liquidity: Evidence from an emerging economy

I investigate the relationship between the stock market liquidity and investors sentiment. The significance of the liquidity in asset pricing is well documented, but little attention is paid in the empirical literature to the effect of investors sentiment on variation in the liquidity. I construct irrational aggregate sentiment index (ASI) measure the institutional investors sentiment. The empirical findings suggest that the stock market is highly liquid when sentiment is bullish and vice versa. Using the non-linear conditional volatility framework and non-linear Granger causality, I show the significant role of investors sentiment in predicting the stock market liquidity. The past psychological biases and herding of investors are associated with the volatility of liquidity through the direct and indirect channels. (C) 2019 Elsevier B.V. All rights reserved.