Diffusion of optimistic and pessimistic investor sentiment: An empirical study of an emerging market

•This study explores the investor sentiments of three major institutional investors.•The paper tests whether investor sentiments are contagious among stock investors.•The results show that investor sentiment contagion is asymmetric.•The diffusion effect of pessimistic sentiment is significant.•Bad news can easily induce a rapid diffusion of pessimistic investor sentiment.

This study explores the optimistic and pessimistic investor sentiments of three major institutional investors (foreign investors, trust investors, and dealers) in the Taiwan stock market and investigates the interactions and effects of these types of sentiment. Related indices are first calculated to examine whether investor sentiments are contagious among stock investors. Next, optimistic and pessimistic sentiments are differentiated to examine how each of them diffuses in the market. Finally, an index of dynamic sentiment spillover is estimated to investigate the diffusion effect of institutional investor sentiment under varying market performance. The results of this study confirm that, under favorable market performance when institutional investors are optimistic, the diffusion effect of investor sentiment is nonsignificant. By contrast, the diffusion effect of pessimistic sentiment is significant, indicating that investor sentiment contagion is asymmetric.