Noise trading and stock market volatility

We investigate the relative effects of fundamental and noise trading on the formation of conditional volatility. We find significant positive (negative) effects of investor sentiments on stock returns (volatilities) for both individual and institutional investors. There are greater positive effects of rational sentiments on stock returns than irrational sentiments. Conversely, there are significant (insignificant) negative effects of irrational (rational) sentiments on volatility. Also, we find asymmetric (symmetric) spillover effects of irrational (rational) bullish and bearish sentiments on the stock market. Evidence in favor of irrational sentiments is consistent with the view that investor error is a significant determinant of stock volatilities. (C) 2006 Elsevier B.V. All rights reserved.