Does investor sentiment affect futures market volatility? Evidence from the Indian index futures market

Abstract

This study investigates the impact of investor sentiments on the volatility of the Indian Index Futures market. Furthermore, this study examines whether the futures market exhibits spillover effects between sentiment and volatility. A sentiment index is constructed using PCA to capture investor sentiment, and it is incorporated into the mean and variance framework of the GARCH (1,1) and EGARCH models to capture investor sentiment in the futures market. The Diagonal BEKK GARCH Model analyses the spillover effect between sentiment and volatility in the Indian Index futures market. The GARCH(1,1) results confirm a significant impact of investor sentiment on futures market volatility, with strong volatility persistence. The EGARCH results confirm a significant investor sentiment effect on the volatility with a leverage effect, indicating that negative shocks impact volatility more than positive shocks. The Diagonal BEKK GARCH results reveal significant bidirectional sentiment volatility spillover in the Indian Index Futures Market. This study makes an original contribution by extending investor sentiment research to the Indian index futures market, an area that has received limited empirical attention. This study provides evidence that investor sentiment significantly influences futures returns, volatility, asymmetric volatility and bidirectional spillovers. By demonstrating the leverage effect of negative news and the dynamic interaction between sentiment and market volatility, the study offers valuable behavioural insights with practical implications for volatility forecasting, market surveillance, regulatory policy and financial stability in emerging derivatives markets.