Pandemic outbreak, investor sentiment and stock market reaction :evidence from the frontier market, Sri Lanka

Abstract

This study examines the impact of COVID-19 pandemic, the resulting investor sentiment in determining stock returns of different sector portfolios, namely, healthcare, telecommunication, banking, insurance, and hotel companies in the Colombo Stock Exchange (CSE), Sri Lanka in the year 2020. The empirical work is drawn on two widely used event study and regression-based econometric analysis. Firstly, the event study methodology focuses on the impact on sector portfolio returns after the World Health Organisation (WHO) declared COVID-19 as a global pandemic on 11 March 2020. Statistically significant positive cumulative average abnormal returns (CARs) are observed surrounding the event day. The most striking phenomenon is positive and persisting CARs perceived after a long Island-wide lockdown curfew, which imposed with effect from 16

March 2020, is lifted on 11 th May 2020. CSE investors are likely to be more sensitive to local events than to global news, and persisting CARs indicate market inefficiency. A second-stage regression-based methodology is adopted to evaluate the impact of pandemic related news and to identify the influence of investor sentiment on sector portfolio returns and its persisting effects. Results reveal an initial negative sentiment effect on portfolio stock returns, followed by a positive sentiment thereafter. Initial negative effect is relatively robust on banks and hotel sector stock returns. A positive sentiment might emanate from overreaction

to the subsequent rebound with the removal of lockdown curfew and the Government’s COVID-relief moratorium packages offered to businesses. Results indicate that CSE investors are likely to react with investment decisions based on psychological bias or sentiment, signifying irrational investor behaviour in CSE. This study provides current findings of investor sentiment, provoked by COVID-19 pandemic, on different sector portfolio returns in the frontier market, CSE, Sri Lanka. th th