Market Sentiment and Stock Return Volatility in Malaysia: Evidence using the GARCH-X Model

Market sentiment is a key determinant of stock market volatility, particularly in globally interconnected economies such as Malaysia. With the rising role of retail investors in digital trading environments, understanding sentiment’s influence on market behavior has become increasingly important. Although regulatory frameworks exist to protect investors, surveillance practices often rely on traditional indicators like price and trading volume, which may not fully capture real market dynamics. This study addresses this gap by empirically examining the effects of market sentiment—measured through the Consumer Sentiment Index (CSI)—alongside macroeconomic variables on stock returns and volatility in Malaysia. Using the GARCH-X Model with stock return data from January 1990 to January 2025, results reveal that CSI has a positive and significant relationship with stock returns. This suggests that investor confidence influenced Malaysia’s stock market returns more strongly than geopolitical events or monetary policy factors. Findings also indicate that the stock market does not always align with macroeconomic fundamentals in the short term. Instead, volatility intensifies during periods of instability, amplifying when new shocks occur. Over the long run, however, the market adjusts and reverts to equilibrium. These results underscore the importance of enhancing regulatory tools for real-time volatility monitoring and improving structured, legal, and accessible data sharing. Such measures would strengthen market resilience and ensure effective responses during crises or adverse global events, ultimately supporting more stable and transparent financial markets in Malaysia.