Aggregating sentiment in Europe: the relationship with volatility and returns

This paper presents several proposals for creating an aggregate sentiment index for the European stock market. We achieve this objective by using the OWA and WOWA operators, which have been successful in finance and have a strong financial interpretation. We compute ten different aggregate sentiment indices for the 2007-2021 period and evaluate their ability to provide information about current and future market volatility and returns. We find several results of interest for both investors and policymakers. Sentiment indices have a strong negative relationship with market volatility. Extreme values of sentiment can predict future market returns, with low values indicating positive returns and high values suggesting negative returns. Finally, using stock market capitalisation as an input of the WOWA operator enhances explanatory power of the indices on future market returns compared to the OWA operator.