# Leveraged Trading, Irrational Sentiment and Sustainability in the Stock Market: Evidence from China

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## Abstract

**:**

## 1. Introduction

## 2. Literature Review

#### 2.1. Sentiment Mechanism and Leveraged Trading

#### 2.2. Feedback Trading and Leveraged Trading

#### 2.3. Multidimensionality of Investor Sentiment and Leveraged Trading

## 3. Leveraged Trading and the Sentiment Feedback Coefficient

#### 3.1. Methodology

#### 3.1.1. Definitions of Core Variables

#### 3.1.2. Empirical Model

#### 3.2. Data and Descriptive Statistics

#### 3.3. Results Presentation and Discussion

^{2}are very significant, and the magnitude of the effect is relatively large. What’s more, the leverage ratio and sentiment feedback coefficients have an “inverted U-shaped” relationship. The turning point for the leverage ratio is about 10.6%. When the leverage ratio does not exceed 10.6% (the corresponding sentiment feedback coefficient is about 4), the higher the leverage ratio, the higher the sentiment feedback coefficient. However, when the leverage ratio exceeds 10.6% (the corresponding sentiment feedback coefficient is about 4), the higher the leverage ratio, the lower the sentiment feedback coefficient, which decreases more quickly when the leverage ratio is higher.

## 4. The Leverage Ratio and Investor Sentiment

#### 4.1. Methodology

#### 4.2. Purification of the Leverage Ratio

#### 4.3. Sentiment Characteristics of the Leverage Ratio

#### 4.3.1. Does the Leverage Ratio have a Systemic Effect on Market Return?

#### 4.3.2. Can the Leverage Ratio Correctly Predict Future Returns?

#### 4.3.3. Is the Leverage Ratio Unrelated to Fundamental Factors, and Will it Be Affected by Past Returns?

## 5. Robustness Test

#### 5.1. Methodology for Robustness Test

#### 5.2. Representation of the Leverage Ratio as a Sentiment Proxy

#### 5.3. Effective of the Inverse Arbitrage Strategies based on Leverage Ratios

_{t-1}is the excess return of the constructed arbitrage portfolio (differences in monthly returns of the low leverage ratio group and the high leverage ratio group), and i represents the lag order. According to the result in Table 5, the leverage ratio can significantly affect the returns of the next three periods. Hence, i = 1, 2, 3.${\alpha}_{t}$ was set as constant to represent excess returns after risk adjustment.

## 6. Conclusions

## Author Contributions

## Funding

## Conflicts of Interest

## References

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**Figure 1.**Time trend of the Shanghai Composite Index (left y-axis) and the leverage ratio (right y-axis).

Variables | Meaning of Variables | Sample Size | Mean | Standard Deviation | Min | Max |
---|---|---|---|---|---|---|

Explained variable: Investors’ sentiment feedback coefficient | ||||||

sentimentfeedback | Investors’ sentiment feedback coefficient | 36 | −0.795 | 5.563 | −10.130 | 8.874 |

Core explanatory variable: Market leverage ratio | ||||||

tradingleverage | Market leverage ratio % | 36 | 10.294 | 1.650 | 6.642 | 14.286 |

Control variables | ||||||

anmktretn | Annualized rate of return % | 36 | 2.144 | 9.428 | −27.709 | 19.662 |

illiquidity | Market illiquidity | 36 | 0.268 | 0.152 | 0.110 | 0.825 |

anvolatility | Annualized volatility % | 36 | 49.688 | 6.662 | 41.635 | 58.375 |

Model 1 | Model 2 | Model 3 | |
---|---|---|---|

Variables | sentimentfeedback | ||

sentimentfeedback _{-1} | 0.000448 | ||

tradingleverage | −0.0310 | 6.561 * | 10.40 *** |

tradingleverage^{2} | −0.309 ** | −0.477 *** | |

anmktretn | 0.427 *** | 0.422 *** | 0.432 *** |

illiquidity | 14.17 ** | 15.33 *** | 11.93 * |

anvolatility | −0.894 ** | −0.790 ** | −0.217 * |

constant | 29.99 ** | −7.273 | −47.87 *** |

N | 36 | 36 | 35 |

Adj R-squared | 0.591 | 0.608 | 0.547 |

F statistic | 26.24 *** | 20.55 *** | 18.75 *** |

Portmanteau (Q) statistic | 9.9202 | 9.4293 | 9.6887 |

_{-1}represents the value of sentimentfeedback lagged one-month term. tradingleverage

^{2}represents the squared value of tradingleverage.

Variables | Leverage Ratio | |
---|---|---|

Market factors | anmktretn (Annualized rate of return %) | −0.0217 |

illiquidity (Market illiquidity) | −1.978 * | |

anvolatility (Annualized volatility %) | −0.0156 | |

Macroeconomic factors | cpi (Consumer Price Index YoY growth %) | 1.709 *** |

iavr (Industrial Added Value YoY growth %) | 0.0809 | |

mci (Macroeconomic Prosperity Index) | −0.245 *** | |

constant | 25.72 *** | |

N | 36 | |

Adj R-squared | 0.724 | |

F statistic | 24.65 *** | |

Portmanteau (Q) statistic | 23.20 |

Variable | Meaning of Variables | Sample Size | Mean | Standard Deviation | Min | Max |
---|---|---|---|---|---|---|

pureleverage | leverage ratio after purification | 36 | 0 | 0.789 | −1.332 | 2.690 |

Market Return (anmktretn _{k}) | Month t − 3 | Month t − 2 | Month t − 1 | Month t | Month t + 1 | Month t + 2 | Month t + 3 |
---|---|---|---|---|---|---|---|

pureleverage_{t} | 0.315 * | 0.340 ** | 0.390 ** | 0 | −0.441 ** | −0.298 * | −0.160 |

_{t}and anmktretn

_{k}(k= t-3, t-2, t-1, t, t+1, t+2, t+3) are listed in Table 5. * represents significance at the 10% significance level; ** represents significance at the 5% significance level.

Months in Advance | pureleverage | Adj R-squared | Months in Advance | pureleverage | Adj R-squared |
---|---|---|---|---|---|

1 | −2.335 | 0.136 | 7 | −0.652 | 0.087 |

2 | −3.735 * | 0.197 | 8 | −1.666 | 0.105 |

3 | −5.079 *** | 0.268 | 9 | 3.987 | 0.175 |

4 | 0.292 | 0.089 | 10 | 1.066 | 0.093 |

5 | 1.176 | 0.096 | 11 | 2.114 | 0.109 |

6 | −1.008 | 0.091 | 12 | 3.509 * | 0.161 |

Item | Optimal Lag Order | F Statistic | chi2 Statistic | Results |
---|---|---|---|---|

anmktretn is not the Granger cause of pureleverage | 3 | 3.36 ** | 12.79 *** | Rejected |

pureleverage is not the Granger cause of anmktretn | 3 | 0.98 | 1.07 | Accepted |

cpi is not the Granger cause of pureleverage | 3 | 0.22 | 0.24 | Accepted |

iavr is not the Granger cause of pureleverage | 3 | 2.07 | 2.26 | Accepted |

mci is not the Granger cause of pureleverage | 3 | 0.65 | 0.71 | Accepted |

**Table 8.**Pearson correlation between the leverage ratio and mainstream irrational sentiment proxies.

Market Turnover | Closed-End Fund Discount Rate | Market Trading Volume | Number of IPO | Number of New Investor Accounts | |
---|---|---|---|---|---|

pureleverage | 0.333 ** | 0.397 ** | 0.244 | 0.380 ** | 0.351 ** |

IPO first-day return | Consumer confidence index | Investorconfidence index | CICSI | ||

pureleverage | −0.002 | 0.172 | −0.041 | 0.359 ** |

CAPM | Three-Factor Model | Four-Factor Model | |
---|---|---|---|

Variables | LMH | ||

Mkt | −0.244 * | −0.163 | −0.144 |

SMB | −0.911 *** | −0.892 *** | |

HML | −1.157 *** | −1.098 *** | |

UMD | −0.0572 | ||

Constant | 2.231 ** | 3.826 *** | 3.579 *** |

N | 35 | 35 | 35 |

Adj R-squared | 0.097 | 0.293 | 0.276 |

F statistic | 3.79 * | 7.83 *** | 6.81 *** |

Portmanteau (Q) statistic | 16.3022 | 11.4502 | 10.8724 |

CAPM | Three-Factor Model | Four-Factor Model | |
---|---|---|---|

Variables | LMH | ||

Mkt | −0.0709 | −0.0618 | 0.0132 |

SMB | −0.206 | −0.135 | |

HML | −0.383 | −0.152 | |

UMD | −0.225 ** | ||

Constant | 1.961 * | 2.302 | 1.326 |

N | 34 | 34 | 34 |

Adj R-squared | −0.020 | −0.057 | 0.007 |

F statistic Portmanteau (Q) statistic | 0.23 28.13 ** | 0.55 23.00 * | 1.92 18.72 |

CAPM | Three-Factor Model | Four-Factor Model | |
---|---|---|---|

Variables | LMH | ||

Mkt | 0.0799 | 0.0449 | 0.106 |

SMB | 0.127 | 0.179 | |

HML | −0.148 | 0.0385 | |

UMD | −0.188 | ||

Constant | 1.766 | 1.524 | 0.765 |

N | 33 | 33 | 33 |

Adj R-squared | −0.019 | −0.035 | −0.003 |

F statistic Portmanteau (Q) statistic | 0.25 25.60 ** | 0.47 22.88 * | 2.40 * 22.03 * |

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## Share and Cite

**MDPI and ACS Style**

Peng, Z.; Hu, C.
Leveraged Trading, Irrational Sentiment and Sustainability in the Stock Market: Evidence from China. *Sustainability* **2020**, *12*, 1310.
https://doi.org/10.3390/su12041310

**AMA Style**

Peng Z, Hu C.
Leveraged Trading, Irrational Sentiment and Sustainability in the Stock Market: Evidence from China. *Sustainability*. 2020; 12(4):1310.
https://doi.org/10.3390/su12041310

**Chicago/Turabian Style**

Peng, Zhen, and Changsheng Hu.
2020. "Leveraged Trading, Irrational Sentiment and Sustainability in the Stock Market: Evidence from China" *Sustainability* 12, no. 4: 1310.
https://doi.org/10.3390/su12041310