Investor sentiment and trading behavior

The aim of this paper is to model trading decisions of financial investors based on a sentiment index. For this purpose, we analyse a dynamical model which includes the sentiment index in the agents' trading behavior. We consider the set up of a Discrete Dynamical System, assuming that in financial markets transactions take place between two groups of fundamentalists that differ in their perception of fundamental value. The proportion of fundamentalists in the two groups is assumed to depend on the sentiment index. The sentiment index used is related to the risk asymmetry index (RAX) enabling us to consider both the variance and the asymmetry of the prediction error between the two groups of fundamentalists. We identify the equilibria of the model and conduct a numerical analysis in order to capture stylized facts documented empirically in the financial literature.