The Impact of Investor Sentiment on Stock Returns in Developed and Emerging Markets: The Case of US and South Korea

This research explores sentiment contagion between the United States and South Korea and examines the extent to which investor sentiment influences stock returns in each market. Employing a vector autoregressive (VAR) framework and separating sentiment into rational and irrational components, we provide strong evidence of sentiment spillovers, showing that U.S. investor sentiment significantly influences Korean sentiment, primarily through the U.S. irrational component. There are also crucial differences in the sentiment-return dynamics between the U.S. and Korean markets. While the effects of sentiment on returns are either insignificant or short-lived in the U.S., both rational and irrational components of sentiment exert a significant and prolonged influence on stock performance in Korea, indicating stronger sentiment effects on valuations in the less efficient emerging market.