Using order flow imbalance as a measure of sentiment we show that positive and negative shocks to sentiment captured by the Smooth Transition Conditional Correlation GARCH model (STCC GARCH model) lead to lower co-movement between portfolio and market returns in the post-shock period. We find an asymmetry is present as positive shocks to sentiment have less impact on co-movement changes than negative shocks. We also find that shocks to retail sentiment and the sentiment of two types of institutional investors leads to a reduction in co-movement. Positive shocks to institutional order flow imbalance lead to smaller reductions in co-movement than associated with retail shocks. These effects exist even after we control for firm specific and market-wide news.
- buy-sell ratio
- smooth transition
- order flow shock and sentiment
- smooth transition model