Modelling the Effect of Investor Sentiments on the Housing Market and Stock Market in Saudi Arabia using Linear ARDL Model

The paper presents a comprehensive study of the relationship between investor sentiment and stock market returns in Saudi Arabia from 2009 to 2022. The study uses linear autoregressive distributed lag models (ARDL) to analyze the complex dynamics between variables. ARDL models are particularly valuable for capturing both long- and short-term relationships between variables and allow for dynamic adjustments over time. The study shows that a positive change in investor sentiment leads to higher stock market returns after a lag of two months, but this positive effect reverses in the long-run, suggesting the possibility of overreaction and subsequent adjustments. Money supply has a consistent positive impact on stock returns over time, while real estate market returns have limited short-term impacts on investor sentiment and macroeconomic factors. The ARDL modeling approach is essential to capture the dynamic interaction between investor sentiment and stock returns and reveals the temporary impact of sentiment on market performance. The study extends its analysis to construct a composite investor sentiment index using principal component analysis, tests the stationarity of stock returns and sentiment index through extended Dickey-Fuller and Phillips-Perron unit root tests, and determines the optimal lag length for time series modeling. The ARDL modeling results for stock market returns and real estate returns provide insights into the short- and long-term relationships between investor sentiment, macroeconomic variables, and market returns; in addition, the study provides important insights into the interaction between investor sentiment and stock market returns in Saudi Arabia, with implications for regulatory policy and investment management. The results demonstrate the impact of investor psychology on market performance, which has practical implications for understanding and managing behavioral risk. The study adopts an integrated approach, combining rigorous ARDL models with economic intuition and practical relevance, which is expected to better understand the dynamic interaction between sentiment and returns.