This research study explores the investor sentiments on stock returns. The co-integration and lead-lag causal relationship is tested in the study. Quarterly data is collected from 49 firms of KSE-100 from 2012 to 2019, covering 1464 observations of secondary data to be analysed with the unbalanced panel. The FMOLS cointegration analysis is used to investigate the long-term relationship between the investor sentiment and stock returns. In addition, the Granger causality is applied to assess the direction and lead-lag relationships between these variables. The empirical results confirm both hypotheses, pointing to the existence of a stable long-run relationship as well as important causal relationships between investor sentiment and stock returns. This study has some limitations related to data constraints and measurement of variables. This research theoretically supports behavioural finance by reinforcing systematic effect of investor sentiments on stock returns that challenges efficient market hypotheses in emerging markets. Practically, the results imply that investors as well as regulators can use sentiment indicators to control volatility, to control risk management strategies, and to increase market stability.

Keywords: Investor sentiment, stock returns, co-integration relationship, lead-lag relationship