Investor Sentiment and Stock Market Returns in Pakistan: Evidence from the Pakistan Stock Exchange

Abstract

Using a quantitative time-series approach, this study set out to analyze how investor sentiment relates to stock-market returns in Pakistan. Daily data on the KSE-100 Index were collected from the Pakistan Stock Exchange and other reliable financial databases for the period 2018–2026. Daily index returns served as the metric for stock-market performance, whereas sentiment was built from market proxies like trading volume, turnover, volatility, and the advance-decline ratio. The empirical work began with descriptive statistics and correlation measures before turning to stationarity tests to check the time-series properties of each series. To see whether sentiment drives returns or returns drive sentiment, the study estimated a Vector Autoregression (VAR) system with Granger causality tests, using impulse-response functions to gauge the market's reaction to sentiment shocks. To verify that the conclusions hold, the analysis was rerun using alternative measures of sentiment. Both the sentiment metrics and KSE-100 returns proved stationary at first differences, Granger causality ran in both directions, and impulse-response paths revealed a significant though brief market response to unexpected sentiment shocks. These outcomes indicate that while past performance partly drives investor mood, sentiment still offers practical short-term predictive value on the Pakistan Stock Exchange, offering useful takeaways for regulators and behavioral investment approaches.