For The 64th Annual Meeting (2011) of the New York State Economics Association Rochester Institute of Technology,

Rochester, NY.

Factors Determining Consumer Sentiment

Evidence from Household Survey Data
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Kajal Lahiri2, Yongchen Zhao3 September 2011

This paper is still a work in progress. Please do not quote or redistribute without permission from author. Comments are welcome. 2 Department of Economics, University at Albany, SUNY, klahiri@albany.edu 3 Department of Economics, University at Albany, SUNY, hzhao@albany.edu or yz881172@albany.edu

Abstract Measures of consumer sentiment have long been used by policy makers and researchers in making monetary policies and forecasting consumption expenditures. Justication for such use centers on the intrinsic information contained in sentiment measures, i.e. what consumer sentiment reects. Unfortunately, the literature has not been able to give a solid conclusion. In this paper, we study the ve components of University of Michigans consumer sentiment index using individual data from household survey for the period from January 1978 to March 2009 in a nonparametric ordered choice model. We nd that the most important set of factors aecting consumer sentiment is their own perceptions and expectations on the economic conditions, both overall and of their own, as well as on the eectiveness of government policies and on information obtained from new media. After this set of factors is controlled for, consumers demographic characteristics, actual macroeconomic conditions, and professional forecasts of future conditions account for little in addition.

1. Introduction
Looking back at the most recent recession, one may nd it surprising that the Index of Consumer Sentiment started to fell before April 2007, while the Stock and Watsons monthly GDP estimates started to fell notably from about May 2008. However, this is merely another time when changes in the Index of Consumer Sentiment lead similar changes in the real economy. Such important relationship between consumer sentiment and the real economy, proved repeatedly by the history of our economy, justies the important role consumer sentiment measures play in business and economic research. However, as is pointed out in Ludvigson (2004), weather consumer condence surveys contain meaningful independent information about the economy is still largely undetermined, even though work has been done (for example, Fuhrer, 1993) to determine the determinants of consumer sentiment. In addition, there has been a prolonged interest in the economic literature in the power of consumer condence to predict future changes in aggregate consumption growth, but the econometric evidence is mixed on the question of whether sentiment aects consumer expenditures once other measured economic factors are allowed for. Early research showed that expectations variables, including the University of Michigan Index of Consumer Sentiment (ICS), usually increases the explanatory power of automobile and consumer durables demand equations ( Juster and Wachtel, 1972 and Mishkin, 1978). The sharp decline in U.S. consumer sentiment in July 1990 and its coincidence with the beginning of the most recent U.S. recession and he Gulf War revived a new, worldwide interest in the condence consumers have regarding the prospects of the domestic economy and its relationship to consumers spending decisions. However, the evidence of the power of sentiment to predict household consumption growth has remained mixed. Throop (1992) nds contemporaneous and lagged consumer sentiment statistically signicant when added to equations for consumer durables and for total consumption. Fuhrer (1993) and Carroll, et al. (1994) again show small but statistically signicant eect of sentiment on consumption growth even when other variables, such as income growth, are accounted for. Bram and Ludvigson (1998) also nd that both measures of U.S. consumer sentiment the University of Michigans Index of Consumer Sentiment and the Conference Boards Index of Consumer Condence have signicant predictive power for several categories of consumer spending even after economic fundamentals are controlled for. In other studies however, sentiment proved redundant in the presence of variables like income, interest rates, and nancial assets and liabilities. Mishkin (178) points out that the presence of nancial asset and liability measures typically reduces consumer sentiment eects to insignicance. Garner (1991) also reports that, regardless of what other variables are included, spending on consumer durables is not aected by the Michigan ICS.
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The international evidence is equally mixed. Berg and Bergstrom (1996), Acemoglu and Scott (1994), and Helfenstein and Wolter (1997) present evidence of signicant predictive power of consumer condence measures in models of consumption for Sweden, the U.K. and Switzerland respectively. However, Fan and Wong (1998) apply the methodology in Carroll, et al. (1994) and nd the eects of sentiment on Hong Kong consumption statistically insignicant. More recently, Easaw, et al. (2005) nd that U.K. consumer condence indices does predict durable good consumption but in predicting consumption growth, consumer sentiment performs better in models using U.K. data then U.S. data. As mainstream economic theory does not explicitly incorporate consumer sentiment in models of consumption, dierent explanations have been suggested for this relationship. At the core of these explanations is the issue of what is reected in consumer sentiment. Competing views of sentiment can be summarized as follows (Fuhrer, 1993): (1) Sentiment independently causes economic uctuations. (2) Sentiment accurately forecasts economic uctuations but does not cause them. (3) Sentiment captures consumers pessimism and hence reects consumers forecasts of economic uctuations, inaccurate as these forecasts may be. (4) Sentiment is a reection of personal, respondent-specic conditions. (5) Sentiment reects only current, widely-known economic conditions. (6) Sentiment measures consumers perceptions of uncertainty and risk, associated with the likelihood of job/income loss. The issue of what is captured by consumer condence measures should be illuminated by an investigation of the factors, which determine sentiment. However, the literature provides a limited discussion of these factors, and oers conicting evidence. For example, Praet and Vuchelen (1989) and Jennings and McGrath (1994) show that increases in the value of the U.S. dollar aects consumer condence in the U.S., Germany and France, but not in the U.K. and Italy. They nd changes in the U.S. stock market index to aect positively German condence, but negatively sentiment in the U.K. and to have no eect in France and Italy. Other studies attempt to explain sentiment with general macroeconomic indicators (Lovell, 1975 and Garner 1981), nancial assets (Mishkin, 1978) and liabilities or political events (Vuchelen, 1985 and Blood and Phillips, 1995). Throop (1992) shows that a structural model for the U.S. ICS including ination rate, unemployment rate and short-term interest rates as explanatory variables explains sentiment fairly well in times of usual political and economic activity but collapses around points of extraordinary events such as the Persian Gulf War. Estelami, et al. (2001) focus on consumer price knowledge and nd that macroeconomic factors explain considerable proportion of variations. In a more recent study, Ludvigson (2004) investigates the relationship between consumer sentiment measures and consumer spending and suggests that it is possible that there are more complex, possibly nonlinear, interactions between consumer condence and economic variables . Vuchelen (2004) shows that a few well-chosen variables explain sentiment of Belgian consumers quite well.

In light of these inclusive ndings, this paper begins by examining the evidence on the explanatory power of sentiment in models for consumption using monthly data on the University of Michigans ICS and on personal consumption expenditures, disaggregated into durable, nondurables, and services for the period 1978:01 to 2009:03. We base our nonparametric estimation on a household level survey data and look very closely at the overall explanatory power of our model as well as the incremental explanatory power of each category of independent variables. Unlike previous studies of this issue, which generally uses quarterly data, we use high-frequency monthly data. Since the original ICS is reported monthly, quarterly data will lose much of the variation in sentiment through averaging. The focus of this paper is the issue of what determines consumer sentiment. All studies on this subject use time series analysis to explain an aggregate measure of consumer sentiment. It should be noted, however, that measures of sentiment are derived from individual survey data, which contain information about consumer expectations and personal characteristics unavailable at the aggregate level. These data can help fully answer the question of what groups of factors aect sentiment, and how much of it is explainable at all. In Section 2, we examine the data used in this study. Section 3 discusses the models and variables, which are grouped into four broad categories. Section 4 focuses on dierent aspects of the explanatory power of our models. Section 5 shifts attentions to individual factors and identies the ones that are important and interesting. Section 6 briey discusses the specication test for our nonparametric model and Section 7 concludes.

2. Survey of consumers
The index of consumer sentiment (ICS) was developed by George Katona (1951) as a measure of consumers changing attitudes about the business conditions and job prospects, and the Survey Research Center at the University of Michigan has continued to produce it on a regular basis to measure consumer condence in the United States. The ICS has generally led the U.S. business cycle and the 1990-1991 recession has been widely attributed to a drop in the ICS in the wake of Iraqs invasion of Kuwait. The SRCs survey of Consumer Attitudes and Behavior on which the ICS is based, started in 1952, and has been conducted quarterly since 1960 and monthly since 1978. The ve questions on which the ICS is based are given below, with their respective range of answers and Figure 1 shows the index itself as well as the ve components of the ICS, corresponding to the following questions. PerFin_Current: We are interested in how people are getting along nancially these days. Would you say that you (and your family living there) are better o or worse o nancially than you were a year ago? Possible responses are: better o; same; worse o.

PerFin_Expected: Now looking ahead do you think that a year from now you (and your family living there) will be better o nancially or worse o, or just about the same as now? Possible responses are: better o; same; worse o. BusCond_12m: Now turning to business conditions in the country as a whole do you think that during the next 12 months well have good times nancially, or bad time, or what? Possible responses are: good times; good with qualications; pro-con; bad with qualications; bad times4. BusCond_5y: looking ahead, which would you say is more likely that in the country as a whole well have continuous good times during the next ve years or so, or that well have periods of widespread unemployment or depression, or what? Possible responses are: good times; good with qualications; pro-con; bad with qualications; bad times. BuyCond: About the big things people buy for their homes such as furniture, refrigerator, stove, television, and things like that. Generally speaking do you thin know is a good or a bad time to buy major household items? Possible responses are: good; pro-con; bad. Based on the responses to the above ve questions, we can compute the balance statistic as follows (% of respondents who answer better or good % of respondents who answer worse or bad) + 100 Then simple average of the ve balance statistics is computed to obtain index of consumer sentiment. The ICS is reported relative the base month February 1960 = 100. For our time series analysis we use monthly data on the ICS dating from January 1978 to March 2009 (375 months). This is the most recent and complete data available to the public at the time this study began. The design of the survey allows us to extract additional information about individuals expectations and perceptions of general and personal economic conditions, as well as personal characteristics, which is not contained in the ve index questions alone. Specically, the survey asks questions regarding the individuals perception of how the economy has done over the past one year, how the government is doing its job at present, and whether the individual has recently heard any good or bad news about the general economic and political situation in the country. There are also questions about the individuals expectations about general economic conditions over the next year, about prices, real income, unemployment, and interest rate on borrowing, all with answers in the threeresponse framework better/same/worse or up/same/down. There is also information about the respondents employment status, education, marital status, gender, race, age, region of
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Responses good time / good with qualifications and bad with qualifications / bad times are grouped together respectively for index construction. Same for the next question.

residence, household size, and annual income. In addition to the response to the ve index questions, we use information on more than 50 other questions to explain response to each of the component questions at the individual level. We used raw data sets from monthly survey, which amounts to a total of 375 months. We have a nal sample contains 156,070 observations.

3. Model and variables

As outlined previously, we utilize the information from over 50 questions from the survey of consumers asked consistently throughout the sample period 1978:01 2009:03 to analyze the factors, which determine individual responses to each of the ve ICS component questions in an ordered response model. The variables we dene are explained in Table 1. In this study we are specically interested in (1) how much of the variation in responses to each question can be explained by expectations and perceptions of general economic conditions; how much is due to personal idiosyncrasies; and how much is an immediate reection of widely known economic conditions ; and (2) what are the main determinants of the responses to each question; are they the same for all of the ve components; and what eect do they have on the components of sentiment measure. Answering these questions will enable us to better discriminate among the existing hypotheses about the informational content of the ICS. As stated before, we combine the response, when necessary, so that for all of the ve components, we have three dierent kinds of responses: good / same / bad or up / same / down. This enables us to consider the questions raised before in a unied latent-variable framework. Let = + where the index corresponds to individual interviewed at time , with lower values of denoting higher optimism, i.e., better/up = 2, same = 1, worse/down = 0, and = ( , , , ) is a vector of variables aecting an individuals level of optimism, in which is individuals expectation and perception, is a set of variables explaining individual idiosyncrasies, is a set of macroeconomic variables and is a set of macroeconomic forecasts. The data for comes from monthly mean of Blue Chip forecasts. The last column of Table 1 shows which variable belongs to which category. Note that a set of monthly dummy variables are included in the category and a dummy variable for whether the economy is in a recession is included in the category. More specically, for each category Expectations/Perceptions ( ) category contains individuals perception on overall news, news specically related to ination, news specically related to unemployment,
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news specically related to war, current business condition compared with that from one year ago and the performance of government economic policies, as well as individuals expectation of future business conditions, future interest rate, future price level, future real income and future unemployment. Personal characteristics/idiosyncrasies ( ) category contains individuals age, real per capita family income, racial origin, marital status, education level, gender and location of residence. Macroeconomics conditions ( ) category contains the levels and percentage changes from previous month of the index of coincident indicators, index of leading indicators, industrial production, S&P 500 index, personal income and purchasing managers index, as well as the levels of ination rate, 3-month treasury bill rate, 5-year government bond rate, unemployment rate, along with a dummy variable indicating NBER recession and the standard deviation of the S&P 500 index in the previous month. Macroeconomic forecasts ( ) category contains monthly mean of Blue Chip forecasts, with one year horizon, of ination rate, real GDP and unemployment rate. Given the latent variable , the observation rule is 0 = 1 2 if < 1 2 if 1 < 2 if

where is an independently distributed error term with distribution function (). The probability of observing response (0, 1, 2) is given by Pr [ = 0] = (1 ) Pr [ = 1] = (2 ) (1 ) Pr [ = 2] = 1 (2 ) For identication, we assume that ( ) is known and there is no constant in . So the model can be estimated by maximum likelihood. The likelihood function is given by

ln() =

=1 =1

(Pr[ = ])

For the error distribution F, we consider two types of specication here. Firstly we consider a usual Probit5 specication, where F = is a normal distribution function. Sec5 A logit specification is also considered and proved to produce very similar results as that produced by a probit specification. Thus, the result from logit model is omitted from this paper but is available from the authors upon request.

ondly, we consider a nonparametric specication (Stewart, 2003) where the density of the error distribution is approximated by a Hermite form 1 () () = ( ) =0 where () is standard normal density and
2 2

=0

()

In the density, we normalize 0 = 0 so that the density is invariant to multiplication of the s. To achieve identication, we also normalize the rst threshold to be the same as the rst threshold estimated using a normal distribution. (Gabler et al., 1993; Melenberg and Soest, 1996) Based on this density function, the distribution function of the error term is thus given by () =
(=0 ) () (=0 ) () 2 2

which is a family of distributions given parameter . As increases, the approximation becomes ner and the computational cost increases accordingly. Based on the willingness to consider normal distribution as an alternative to this more general form of nonparametric distribution, we are accepting the assumption that the true error distribution is not wildly oscillatory, which means the above nonparametric distribution is able to approximate the true error distribution well. Under regularity conditions, the parameters in the nonparametric model can be estimated consistently given that is increasing with sample size (Gallant and Nychka, 1987). In this study, is chosen for each of the ve components separately according to the BIC statistic. To facilitate the comparison of the eects of dierent variables on components of sentiment index, alongside the estimated coecients we show the marginal eects for each possible value of the dependent variable. The marginal eect of at = measures the change in the predicted probability that will take on the value resulting from a unit increase in . The standard methodology for computing marginal eects is to take derivative of the predicted probability of = with respect to . For the nonparametric model in this study, the predicted probabilities are Pr [ = 0] = ( 1 ) Pr [ = 1] = ( 2 ) ( 1 ) Pr [ = 2] = 1 ( 2 )
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where the hatted values denote estimates. And the marginal eects are given by ( = 0) = ( 1 )| | | |=

( = 1) =

[ ( 2 ) ( 1 )]| | | |= [1 ( 2 )]| | | |=

( = 2) =

and the maximum likelihood where the derivatives are evaluated at the sample means estimates , 1 and 2 . This computation is appropriate when is a continuous variable, but for a dummy variable , we use the following alternative method to calculate the marginal eect (Caudill and Jackson, 1989), , ( = ) = Pr [ = | = 1, , , , 1 2 ] Pr [ = | = 0, , , 1 2] where (0, 1, 2).

4. Explanatory power
The rst question we address here is how much variation in each of the ve sentiment components can be explained. To measure the explanatory power of our model, we use the statistic proposed by McKelvey and Zavoina (1975), modied to take into acpseudo- count the feature of the nonparametric distribution, which is given by 2 = where
2 = = 2 =1 =1 2 =1 =1 + ()

measures the proportion of variation in the underlying latent variable The pseudo- explained by the model. Table 2 shows the proportion of variation explained by the full model, and by each group of factors separately and the explanatory power of the model reported in Tafor the full sample and for the last 10 years separately. The incremental resulting from the addition of each group of ble 2 refers to the change in pseudo- factors to the rest of the variables. Overall explanatory power: From the table we can see that in terms of overall explanatory power, the model explains from 17% to 56% of the total variation. BusCond_12m
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the one-year ahead expectation of the overall business condition is best explained with a of 55.86% in probit model and 54.50% in nonparametric model. The least well pseudo- explained variables are PerFin_Current personal nancial condition compared to a year of ago and BuyCond buying condition for large household items, with a pseudo- around 17-18% for both the probit model and the nonparametric model. Considering that BusCond_5y expectation of ve year ahead business condition is the second best about 40% and PerFin_Expected expectation of explained variable with a pseudo- one year ahead personal nancial situation is the third best explained variable with a of about 30-40%, we come to the conclusion that the model explains expectapseudo- tions about the overall economic condition better that it explains expectations about personal situation. This observation is further conrmed by that fact that macroeconomic variables accounts for a larger proportion of variation in explaining overall business conditions. Another nding we get from Table 2 is that in terms of overall explanatory power, the probit model provides a result that is highly consistent with what the nonparametric for four of the ve variables are within 1 to model provides. The dierences in pseudo- 2%, except for PerFin_Expected. While the probit model explains about 30% of the total variation of this variable, nonparametric model explains about 50%. This obvious increase in explanatory power may be due to the non-normality of the error distribution for this variable. Explanatory power of each category: In terms of the explanatory power of each category of variables, the two models again give highly consistent results. Generally, expectations and perceptions category has the highest incremental explanatory power, ranging from about 10% for BuyCond and PerFin_Current to 52% for BusCond_12m. In the rest of the categories, personal idiosyncrasies category plays an important role in explaining Per of 8-10% for the former and 5Fin_Current and PerFin_Expected, providing pseudo- 8% for the later. Macroeconomic variables and macroeconomic forecasts play equally important role in explaining business conditions and buying condition. And not surprisingly, these two categories are more important in explaining BusCond_12m than the rest two variables. Note that while overall explanatory power for BusCond_5y is much higher than that for BuyCond, macroeconomic variables and macroeconomic forecasts are much less important in BusCond_5y. This shows that uncertainty of long-term expectation of business condition is so large that the variation caused by idiosyncratic factors is much more than variations caused by the variation in the common information set current and professionally forecasted economic conditions. Incremental explanatory power: As for incremental explanatory power, while there are more notable dierences in the results produced by the probit model and the nonparametric model, the general conclusions we can draw from Table 2 in still clear. Once we control for the rest of the variables, addition of macroeconomic variables and macroeconomic forecasts provide the least additional benet, i.e., explanatory power. This is especially obvious when looking at the results provided by the probit model. The nonparametric model shows that for PerFin_Expected, adding macroeconomic variables or
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macroeconomic forecasts to the model with other variables already in it brings another , which is quite notable considering that the benet of doing so for other 18% pseudo- components of sentiment index is usually quite negligible 6% for PerFin_Current and less than 1% for business conditions and buying condition. Time variation in explanatory power: Another interesting perspective from which we can look at the results is the time variation in explanatory power. We rst estimated the probit model for the last 10 years (2000 to 2009). In terms of overall explanatory power, there is marginal improvement for four of the ve components. For BuyCond, the explanatory power for the last 10 years is about 1% less than that for the entire sample period from 1978 to 2009. In terms of the incremental explanatory power of each component, we nd that despite the increase in overall explanatory power if we restrict the sample to the last 10 years, the contribution of macroeconomic variables and macroeconomic forecasts are generally even less. To show how the explanatory power evolves over plot for each of the ve components in the years, we presented a year by year pseudo- Figure 2. From the gure we can see that explanatory power for BusCond_12m and BusCond_5y basically follow the same trend, except that we see a dramatic increase in explanatory power for BusCond_12m since 2008 while that for BusCond_5y remained low for the same period. Explanatory power for PerFin_Current and PerFin_Expected also share almost the same trend in the earlier years. But since 2007, explanatory power for PerFin_Current dropped sharply while that for PerFin_Expected remained the same. We think this is partly because the most recent recession is so strong that short term uncertainty spiked causing a decrease in explanatory power for personal variables but an increase for economic conditions. In other words, during the recent recession, while consumers are more uncertain about their own conditions, they are less able to form an independent view regarding the overall business conditions, resulting in an increased reliance on macroeconomic variables and forecasts in forming such view.

5. Main determinants
We have discussed the explanatory power of the model and its variation across the ve components of the sentiment index and variation over the entire sample period. In this section we focus on the individual factors in each category that has interesting and important impact on the components of sentiment. Table 3 to 7 give the regression result of the nonparametric model for each of the sentiment components where marginal eects are reported alongside the estimated coecients. Expectations and perceptions: We nd that perception of government economic policy has an important role in explaining PerFin_Current, BusCond_12m, and BusCond_5y. On average, the marginal eect of perception of government performance is about 2 to 3%; meaning that other things being equal, the likelihood of people have a good sentiment is 2-3% higher if they think the government is doing a good job. Interestingly, the eect of this on PerFin_Expected and BuyCond is much smaller. A possible explanation
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is that while consumers do think that government economic policy is important to the overall economy and to the change in their own nancial situation, they tend not to think of it as an important factor in forming expectation about their own future and making their own purchasing decisions. Meanwhile, we nd that the eect on the sentiment is bigger if consumers think the government is doing a poor job than the eect if consumers think the government is doing a good job. We also nd that whether consumers have heard any good or bad news mainly aects BusCond_12m but not the rest of the components, in particular, BusCond_5y. This may be because of the time-sensitiveness nature of news stories they mostly focus on whats happening now instead of on whats going to happen in a relatively long term. In addition, our result shows that good news has a bigger eect than bad news, somehow contradicting to traditional wisdom that consumers are more sensitive to bad news. The marginal eect of good news on BusCond_12m is about 3% while that of bad news is less than 1%. In the rest of the variables in this category, consumers perception and expectation of overall economic condition, price level, and real income are the most important factors in terms of magnitude of marginal eects. Personal idiosyncrasies: In terms of racial origin, we nd that white consumers generally have higher sentiment, in all ve sentiment components, then black consumers, then Hispanics. For example, white consumers are about 2-3% more likely to think that their own nancial situations as well as the general economic conditions have been improving and will continue to improve in the future. This number is generally less than 1% (or not statistically signicant) for black consumers and Hispanics. In terms of gender, male consumers tend to have higher sentiment, especially for long term expectations BusCond_5y, where mail consumers are 4% more likely to have higher sentiment or unlikely to have lower sentiment. For other components of sentiment, the marginal eect of being male is generally 2-3%. The level of education also has a signicant eect on consumer sentiment, though the eect is not so clear for some components of sentiment. Our result shows that consumers with higher education level have signicantly higher sentiment in PerFin_Current and BusCond_5y consumers with a college degree or higher are about 1.5% more likely to have higher sentiment than consumers without high school diploma. For the rest of the sentiment components, the eect of education is not clear. As for residence location, we nd that for current personal nancial situation PerFin_Current, consumers residing in the south have higher sentiment then consumers residing in the west and the consumers residing in the northeast have lowest sentiment. For expected personal nancial situation PerFin_Expected and 12-month ahead expectation of business conditions BusCond_12m, consumers from the west have higher sentiment than consumers from northeast. For the rest of the sentiment components, the eect of location of residence is not clear. Macroeconomic variables and forecasts: Macroeconomic variables and macroeconomic forecasts are generally not so important in determining personal nancial situations, both past and expected, PerFin_Current and PerFin_Expected, though an increase in unemployment increases consumers sentiment in PerFin_Current. The rationality behind this
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seemingly unreasonable result may be that the worse the condition for their peers, the better the consumers feel for themselves, provided that most of them are still employed. As for business conditions, changes in industrial production, forecasted ination, 5-year government bond rate and unemployment rate has strong eects on BusCond_12m, while the index of coincident indicators and forecasted unemployment rate strongly aect BusCond_5y. For example, a 1% increase in industrial production makes consumers 1.13% more likely to think that the overall business condition will be better in one year; a 1% increase in the coincident indicator makes consumers 1.27% more likely to think that business condition will be better in ve years. Unemployment also has a strong eect on BuyCond. Information content of sentiment: While the current setting of the model does not permit a statistical test on the information content of consumer sentiment, the above analysis and ndings do provide some solid clues. In general, we nd that sentiment captures consumers perception and expectation of economic uctuations, based on their dayto-day experience (hypothesis 3 and 4). Firstly, variation in the sentiment components can be largely explained by variation in consumers perception and expectations of their own situation, the information they get from news media as well as the condition of the economy, at least the part of the economy they experience. If sentiment was an unmediated experience, and reects nothing more than ocial statistical reports, professional forecasts and noise, as in hypothesis 5, we would expect actual lagged macroeconomic variables and macroeconomic forecasts to be able to explain a large portion of the variation in sentiment on the individual level. However, we nd contrary. Moreover, macroeconomic variables and macroeconomic forecasts, by themselves, do not provide suciently large explanatory power, as can be seen from Table 2. Secondly, sentiment is clearly not a direct reection of political and business news, otherwise, our news variables would be expected to capture a lot more variations then what they do now. Not to mention that even they do capture a lot more variation, they are still the perception of the consumers, i.e., dierent consumers may interpret the same piece of news dierently, especially when such interpretation is used to form expectation of the future. Our results show that new variables generally have less than 2-3% marginal eect, about the same as all other important variables. In particular, news of war, unemployment and ination do not have any important eects on sentiment components, which make us believe that consumers tend not to overreact to particular word(s) that appear in news report. So it is highly unlikely that one news story containing a particular bad word, e.g., the r word recession would trigger a sudden fall in consumer sentiment. This is supported by the result that good news has larger eect on sentiment compared with bad news. The weak performance of news variables as determinants of sentiment directly contradicts the results of Blood and Phillips (1995), who nd that recession related headline news have a signicant negative prior inuence on ICS, even after accounting for the actual state of the economy. Our ndings support the view of Linden (1982) and Blendon, et al. (1997) that consumers expectations are formed in conversations between neighbors over the backyard fence and are not a direct reection of media coverage or published statistics (Garner, 1991). Finally, we
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nd a clear dierence between consumers sentiment regarding their own personal situations and the conditions of the overall economy. Their personal situations are more likely to be aected by their demographic characteristics and other idiosyncrasies rather than macroeconomic variables or their forecasts. But macroeconomic variable do greatly aect consumers sentiment on business conditions. Expected business conditions have marginal eects about 4-6% for BusCond_12m and BusCond_5y. Expected prices, expected income and expected unemployment situation generally have marginal eects about 1-2% for BusCond_12m and BusCond_5y. Expected business condition and expected employment are also important in BuyCond, with marginal eects more than 1%.

6. Specification test
Since both the probit model and the nonparametric model are estimated by maximum likelihood method, we can test the validity of the nonparametric distribution against normal distribution using a standard likelihood ratio test. Let 0 be the log-likelihood value of the nonparametric model and 1 be the log likelihood value of the probit model, with 0 the degree of freedom of the nonparametric model and 1 the degree of freedom for the probit model, the test statistic is = 2(1 0 ) which is approximately 2 with (0 1 ) degrees of freedom. The result of the test is given in Table 8. As we can see from the table, nonparametric specication is accepted for all ve components of the index of consumer sentiment. Though we have to note here that while nonparametric specication does indeed produce dierent result than the probit specication, the basic conclusions regarding the overall explanatory power and the importance of variables one can draw from the two set of results are the same. From Panel IV of Table 2 we can see that nonparametric model provides stronger explanatory power than the probit model when only variables from each category are included. We also note here that nonparametric estimation used in this study is highly computationally costly and probit model is a good alternative in this sense.

7. Summary
In this study, we focus on the informational content of the Index of Consumer Sentiment, in particular, its ve components. Models based on household level survey data are estimated assuming normal error distribution as well as assuming nonparametric distribution. Our results provide some solid clue on how much we can explain variations in the components of consumer sentiment, what are the important factors aecting components of consumer sentiment, and what information consumer sentiment index reects.

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We nd that up to 48% of variations in personal sentiment, and up to 56% of variations in sentiment on business conditions can be explained by variables including consumers perception and expectation of social economic fundamentals, macroeconomic variables and their professional forecasts, and consumers demographic characteristics such as gender, racial origin, education level, age, and region of residence. Among them, consumers perception and expectation are the most important category of variables, accounting for 11% to 53% of the total variation in components of sentiment. Macroeconomic variables and forecasts generally provide much lower explanatory power around 5% to 20%, especially for personal sentiment components where they only provide about 3% to 5% explanatory power. The most important and inuential factors aecting components of sentiment at the individual and household level are consumers expectation of future business conditions and unemployment level, as well as consumers perception of the performance of government economic policies and news stories. Consumers response to general questions regarding, for example, the overall business condition contains complex information from all sources and balance statistics constructed for this kind of questions are not easy to interpret. Our results thus suggest the incorporation of the statistics constructed from direct questions about expected unemployment or family income in the sentiment index. The above nding suggests that the informational content of consumer sentiment is complex yet tractable. The information contained in sentiment measure is neither purely macroeconomic uctuation nor the tone of news reports delivered by mass media. Rather, dierent information takes up the role of the principle driving force for dierent component of consumer sentiment. It is more informative if components of the sentiment index are treated separately in economic and econometric models. When the components are combined, information of the driving force of changes in sentiment may be obscured.

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References
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Garner A. Forecasting consumer spending: should economists pay attention to consumer condence surveys? Economic. 1991:57. Helfenstein R, Wolter SC. Unemployment, consumer condence and private consumption in Switzerland. In: Business and Economics for the 21st Century, Volume 1.; 1997. Jennings EJ, McGrath P. Consumer sentiment and international conditions. The Journal of Economics. 1994;XX:17-21. Juster FT, Wachtel P. Anticipatory and objective models of durable goods demand. The American Economic Review. 1972;62(4):564579. Katona G. Toward a macropsychology. American Psychologist. 1979;34(2):118126. Katona G. Psychological analysis of economic behavior. McGraw-Hill New York; 1951. Linden F. The consumer as forecaster. Public Opinion Quarterly. 1982;46(3):353360. Lovell MC. Why Was the Consumer Feeling So Sad? Brookings Papers on Economic Activity. 1975:473479. Ludvigson SC. Consumer condence and consumer spending. Journal of Economic Perspectives. 2004;18(2):2950. MacKuen MB, Erikson RS, Stimson JA. Peasants or bankers? The American electorate and the US economy. The American Political Science Review. 1992;86(3):597611. Maddala GS. Limited-dependent and qualitative variables in econometrics. Cambridge Univ Pr; 1986. McKelvey RD, Zavoina W. A statistical model for the analysis of ordinal level dependent variables. The Journal of Mathematical Sociology. 1975;4(1):103120. Melenberg B, Soest AHOV. Measuring the costs of children: Parametric and semiparametric estimators. Statistica Neerlandica. 1996;50:171-192. Mishkin FS, Hall R, Shoven J, Juster T, Lovell M. Consumer sentiment and spending on durable goods. Brookings Papers on Economic Activity. 1978:217232. Praet P, Vuchelen J. The contribution of consumer condence indexes in forecasting the eects of oil prices on private consumption. International Journal of Forecasting. 1989;5(3):393397. Stewart MB. Semi-nonparametric Estimation of Extended Ordered Probit Models. The Stata Journal. 2003;4(1):27-39. Throop AW. Consumer sentiment: Its causes and eects. Federal Reserve Bank of San Francisco Economic Review. 1992;1:3559. Vuchelen J. Consumer sentiment and macroeconomic forecasts. Journal of Economic Psychology. 2004;25(4):493506. Vuchelen J. Political events and consumer condence in Belgium. Journal of economic psychology. 1995;16(4):563579. 18

Table 1 - Variable Description

Variable Name YYYYMM BusCond_12m BusCond_5y BuyCond PerFin_Current PerFin_Expected BadNewsOnly BNIn BNUnemp BNWar BusCond_Better BusCond_Worse EBusCond_Better EBusCond_Worse EInt_Rate_Down EInt_Rate_Up EPrices_Down EPrices_Up EReal_Income_down EReal_Income_Up EUnempl_Less EUnempl_More GNIn GNUnemp GNWar GoodGovt GoodNewsOnly PoorGovt Age AgeSq Apr Aug Black Divorced Feb Grade_9_11 High_School Hispanic Income Jan Jul Jun Male Mar Married May North_Central Northeast Nov Oct Sep Description Year and month of the observation Expected overall business conditions in 1 year Expected overall business conditions in 5 years Whether now is a good time to buy major household items Personal nancial situation compared to 1 year ago Expected personal nancial situation in 1 year True if GoodNews = 0 and BadNews = 1 Bad news about ination has been heard in past several months Bad news about unemployment has been heard in past several months Bad news about war/defense has been heard in past several months Business condition better than one year ago Business condition worse than one year ago Expect business conditions to be better in one year Expect business conditions to be worse in one year Expect interest rate to go down in one year Expect interest rate to go up in one year Expect prices to go down in one year Expect prices to go up in one year Expect income to increase less than price in one year Expect income to increase more than price in one year Expect lower unemployment rate in one year Expect higher unemployment rate in one year Good news about ination has been heard in past several months Good news about unemployment has been heard in past several months Good news about war/defense has been heard in past several months Government is considered doing a good job True if GoodNews = 1 and BadNews = 0 Government is considered doing a poor job Age Square of age True if interviewed in Apr True if interviewed in Aug Black Divorced True if interviewed in Feb Highest education level is grade 9 to 11 Highest education level is high school Hispanic Total real annual family income adjusted for size of family True if interviewed in Jan True if interviewed in Jul True if interviewed in Jun Male True if interviewed in Mar Married True if interviewed in May Lives in north central Lives in northeast True if interviewed in Nov True if interviewed in Oct True if interviewed in Sep Group

E E E E E E E E E E E E E E E E E E E E E E I I I I I I I I I I I I I I I I I I I I I I I

19

Some_College South White Widowed C_ICI C_ILI C_Indpro C_PI C_PMI C_SP500 ICI ILI In Irate_3m Irate_5y PMI Recession Std_SP500 Unemp F_In F_RGDP F_Unemp

Highest education level is college but no degree Lives in south White Widowed Change in ICI from previous month Change in index of leading indicators Change in industrial production from previous month Change in personal income from previous month Change in PMI from previous month Change in SP500 index from previous month Index of composite indicators Index of leading indicators Ination rate 3 month T-bill rate 5 year government bond rate Purchasing managers' index True if the economy is in recession when interview conducted Standard deviation of SP500 index Unemployment rate Forecasted ination rate Forecasted real GDP Forecasted unemployment rate

I I I I M M M M M M M M M M M M M M M F F F

20

Table 2 Summary Statistics

Variable YYYYMM BusCond_12m BusCond_5y BuyCond PerFin_Current PerFin_Expected BadNewsOnly BNIn BNUnemp BNWar BusCond_Better BusCond_Worse EBusCond_Better EBusCond_Worse EInt_Rate_Down EInt_Rate_Up EPrices_Down EPrices_Up EReal_Income_Down EReal_Income_Up EUnempl_Less EUnempl_More GNIn GNUnemp GNWar GoodGovt GoodNewsOnly PoorGovt Age AgeSq Apr Aug Black Divorced Feb Grade_9_11 High_School Mean 199271 1.0565 0.9320 1.5103 1.1493 1.2698 0.1822 0.0526 0.1162 0.0120 0.4150 0.4687 0.2874 0.1971 0.1885 0.5075 0.0361 0.7962 0.3523 0.2136 0.1582 0.3583 0.0157 0.0383 0.0021 0.2265 0.5008 0.2635 43.8424 2189.24 0.0812 0.0843 0.0866 0.1399 0.0815 0.1021 0.3163 Std. Dev. 898.335 0.9811 0.9494 0.8350 0.8478 0.6610 0.3860 0.2232 0.3205 0.1088 0.4927 0.4990 0.4526 0.3978 0.3911 0.4999 0.1866 0.4028 0.4777 0.4099 0.3649 0.4795 0.1241 0.1919 0.0462 0.4185 0.5000 0.4405 16.342 1599.0 0.2731 0.2779 0.2813 0.3469 0.2736 0.3028 0.4650 Variable Hispanic Income Jan Jul Jun Male Mar Married May North_Central Northeast Nov Oct Sep Some_College South White Widowed C_ICI_L1 C_ILI_L1 C_Indpro_L1 C_PI_L1 C_PMI_L1 C_SP500_L1 ICI_L1 ILI_L1 In_L1 Irate_3m_L1 Irate_5y_L1 PMI_L1 Recession Std_SP500_L1 C_SP500_L1 Unemp_L1 F_In_L1 F_RGDP_L1 F_Unemp_L1 Mean 0.0457 8.5866 0.0848 0.0848 0.0849 0.4576 0.0795 0.6053 0.0810 0.2738 0.1931 0.0851 0.0842 0.0845 0.2289 0.3328 0.8436 0.0760 0.1486 0.1812 0.1564 0.5342 -0.0745 0.7440 80.5226 70.3767 4.2227 6.1599 7.4914 50.9964 0.1694 10.2174 0.7440 6.2351 4.2195 2.6334 6.2893 Std. Dev. 0.2088 9.5923 0.2785 0.2786 0.2788 0.4982 0.2705 0.4888 0.2728 0.4459 0.3948 0.2791 0.2777 0.2781 0.4201 0.4712 0.3632 0.2649 0.3210 0.6855 0.6898 0.5381 4.9047 4.3604 15.9750 19.6007 4.3971 3.4187 3.2435 6.1926 0.3751 11.2467 4.3604 1.5001 2.5306 1.5390 1.3942

21

Table 3 Regression Result Current Financial Situation

Variable GoodGovt PoorGovt BusCond_Better BusCond_Worse Married Divorced Widowed Grade_9_11 High_School Some_College White Black Hispanic North_Central Northeast South Male Age AgeSq Income Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Std_SP500_L1 Unemp_L1 Irate_3m_L1 In_L1 In_L2 Irate_5y_L1 C_12m_SP500 C_12m_Indpro C_ILI_L1 Thresholds 1 2 Coef. 0.1777 -0.2289 0.2746 -0.1594 0.1183 -0.0028 -0.0055 -0.1997 -0.1349 -0.0921 0.0756 0.0718 0.0158 -0.0149 -0.0610 0.0311 0.0400 -0.0427 0.0003 0.0151 0.0327 0.0281 0.0276 0.0293 0.0094 0.0111 0.0510 0.0456 0.0182 -0.0121 0.0040 -0.0015 -0.0670 -0.0263 -0.0033 -0.0018 0.0312 0.0009 0.0016 0.0181 -1.9007 -1.1448 Std. Err. 0.0084 0.0074 0.0108 0.0091 0.0100 0.0125 0.0140 0.0115 0.0081 0.0085 0.0210 0.0239 0.0253 0.0089 0.0095 0.0087 0.0063 0.0011 0.0000 0.0009 0.0145 0.0149 0.0148 0.0147 0.0145 0.0146 0.0149 0.0146 0.0145 0.0145 0.0145 0.0004 0.0037 0.0040 0.0011 0.0010 0.0046 0.0002 0.0014 0.0056 SNP Coefs 1 2 3 z 21.050 -31.060 25.380 -17.510 11.810 -0.220 -0.390 -17.310 -16.630 -10.810 3.590 3.000 0.620 -1.680 -6.400 3.580 6.350 -40.290 26.770 17.470 2.250 1.890 1.870 2.000 0.650 0.760 3.440 3.110 1.250 -0.840 0.280 -3.930 -18.070 -6.550 -3.180 -1.750 6.810 3.740 1.130 3.250 0.2642 -0.0465 -0.1017 P>z 0.0000 0.0000 0.0000 0.0000 0.0000 0.8240 0.6970 0.0000 0.0000 0.0000 0.0000 0.0030 0.5340 0.0930 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0240 0.0590 0.0610 0.0460 0.5160 0.4460 0.0010 0.0020 0.2100 0.4030 0.7830 0.0000 0.0000 0.0000 0.0010 0.0800 0.0000 0.0000 0.2580 0.0010 ME(y=1) -0.0059 0.0373 -0.0006 0.0226 -0.0152 0.0003 0.0005 0.0308 0.0181 0.0111 -0.0087 -0.0049 -0.0014 0.0014 0.0068 -0.0025 -0.0031 0.0017 NA -0.0014 -0.0033 -0.0023 -0.0023 -0.0024 -0.0008 -0.0010 -0.0038 -0.0035 -0.0016 0.0011 -0.0004 0.0001 0.0061 0.0024 0.0003 0.0002 -0.0028 -0.0001 -0.0001 -0.0016 Est. Error dist. Variance Skewness Kurtosis ME(y=3) 0.0765 -0.1026 0.1158 -0.0713 0.0529 -0.0012 -0.0024 -0.0895 -0.0603 -0.0411 0.0337 0.0315 0.0070 -0.0066 -0.0272 0.0137 0.0176 -0.0083 NA 0.0067 0.0145 0.0124 0.0122 0.0129 0.0042 0.0049 0.0224 0.0201 0.0080 -0.0054 0.0018 -0.0007 -0.0296 -0.0117 -0.0015 -0.0008 0.0138 0.0004 0.0007 0.0080 1.2711 -0.5636 4.4083

22

Table 4 Regression Result Expected Financial Situation

Variable GoodNewsOnly BadNewsOnly GNIn BNIn GoodGovt PoorGovt BusCond_Better BusCond_Worse EBusCond_Better EBusCond_Worse EPrices_Down EPrices_Up EReal_Income_Up EReal_Income_Down EUnempl_Less EUnempl_More EInt_Rate_Up EInt_Rate_Down Married Divorced Widowed Grade_9_11 High_School Some_College White Black Hispanic North_Central Northeast South Age AgeSq Income Recession C_SP500_L1 In_L1 ICI_L1 Irate_5y_L1 F_In_L1 F_Unemp_L1 C_ILI_L1 Thresholds 1 -2.0347 2 0.3957 Coef. -0.0139 -0.0467 0.1026 -0.0533 0.0526 -0.1382 0.0646 -0.0739 0.4508 -0.4268 0.0159 -0.0337 1.0337 -0.5687 0.1080 -0.1027 0.0092 0.0379 0.0128 0.2538 0.1225 -0.1599 -0.0214 0.0615 0.1024 0.3827 0.0938 -0.1230 -0.1606 -0.0230 -0.0018 -0.0002 -0.0011 -0.0322 0.0022 -0.0032 0.0002 0.0093 -0.0322 -0.0712 0.0167 Std. Err. 0.0107 0.0135 0.0368 0.0209 0.0118 0.0114 0.0143 0.0146 0.0152 0.0139 0.0269 0.0119 0.0291 0.0153 0.0140 0.0108 0.0101 0.0131 0.0138 0.0181 0.0213 0.0168 0.0113 0.0123 0.0297 0.0348 0.0368 0.0134 0.0145 0.0128 0.0016 0.0000 0.0005 0.0140 0.0010 0.0013 0.0005 0.0029 0.0032 0.0050 0.0080 SNP Coefs 1 2 3 4 z -1.3000 -3.4500 2.7900 -2.5500 4.4500 -12.0800 4.5200 -5.0700 29.6400 -30.6900 0.5900 -2.8300 35.5600 -37.2300 7.7300 -9.4700 0.9100 2.8800 0.9300 13.9800 5.7400 -9.5100 -1.8900 5.0000 3.4500 11.0000 2.5500 -9.1900 -11.0700 -1.8000 -1.1300 -11.1600 -2.0200 -2.3100 2.1600 -2.4600 0.3800 3.2200 -10.0800 -14.3800 2.0900 0.1982 -0.0115 0.0461 0.0388 P>z 0.195 0.001 0.005 0.011 0.000 0.000 0.000 0.000 0.000 0.000 0.555 0.005 0.000 0.000 0.000 0.000 0.363 0.004 0.352 0.000 0.000 0.000 0.058 0.000 0.001 0.000 0.011 0.000 0.000 0.072 0.258 0.000 0.044 0.021 0.030 0.014 0.701 0.001 0.000 0.000 0.036 ME(y=1) -0.0027 -0.0088 0.0209 -0.0101 0.0105 -0.0249 0.0129 -0.0138 0.1028 -0.0629 0.0031 -0.0066 0.2487 -0.0741 0.0220 -0.0189 0.0018 0.0075 0.0025 0.0547 0.0251 -0.0284 -0.0041 0.0123 0.0188 0.0858 0.0190 -0.0223 -0.0285 -0.0044 -0.0035 -0.0002 -0.0062 0.0004 -0.0006 0.0000 0.0018 -0.0062 -0.0138 0.0032 Est. Error dist. Variance Skewness Kurtosis ME(y=3) -0.0034 -0.0114 0.0255 -0.0130 0.0130 -0.0332 0.0160 -0.0179 0.1175 -0.0988 0.0039 -0.0083 0.2846 -0.1292 0.0269 -0.0248 0.0023 0.0093 0.0031 0.0644 0.0305 -0.0384 -0.0052 0.0152 0.0248 0.0989 0.0233 -0.0297 -0.0385 -0.0056 -0.0045 -0.0003 -0.0079 0.0006 -0.0008 0.0000 0.0023 -0.0079 -0.0175 0.0041 2.0168 -0.2507 3.3560

23

Table 5 Regression Result Business Condition 12m

Variable GoodNewsOnly BadNewsOnly GNWar BNWar GNUnemp BNUnemp GNIn BNIn GoodGovt PoorGovt BusCond_Better BusCond_Worse EBusCond_Better EBusCond_Worse EPrices_Up EPrices_Down EReal_Income_Up EReal_Income_Down EUnempl_Less EUnempl_More EInt_Rate_Up EInt_Rate_Down Married Divorced Widowed Grade_9_11 High_School Some_College White Black Hispanic North_Central Northeast South Male Age AgeSq Income Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Recession C_SP500_L1 C_SP500_L2 C_SP500_L3 Coef. 0.1373 -0.1335 -0.0566 -0.1783 0.0817 -0.0167 0.0858 -0.0737 0.2762 -0.3306 0.2910 -0.5098 0.5419 -0.8572 -0.0537 -0.0212 0.1129 -0.2020 0.1653 -0.4126 -0.0946 -0.0284 0.0474 0.0028 -0.0486 -0.0919 -0.0048 0.0144 0.0779 0.0010 -0.0441 -0.0200 -0.0586 0.0088 0.1576 -0.0078 0.0001 0.0021 0.0757 0.0252 0.0580 0.0320 0.0373 0.0361 0.0275 0.0156 0.0428 0.0247 0.0333 -0.1230 0.0090 0.0102 0.0068 Std. Err. 0.0116 0.0143 0.0809 0.0379 0.0211 0.0143 0.0318 0.0208 0.0164 0.0184 0.0183 0.0253 0.0270 0.0432 0.0106 0.0230 0.0120 0.0129 0.0147 0.0202 0.0098 0.0117 0.0120 0.0151 0.0203 0.0159 0.0100 0.0106 0.0261 0.0289 0.0310 0.0115 0.0126 0.0111 0.0109 0.0014 0.0000 0.0004 0.0195 0.0195 0.0198 0.0192 0.0192 0.0192 0.0192 0.0190 0.0191 0.0192 0.0190 0.0159 0.0011 0.0011 0.0010 z 11.8700 -9.3200 -0.7000 -4.7000 3.8600 -1.1700 2.7000 -3.5500 16.8400 -17.9400 15.9400 -20.1900 20.0600 -19.8600 -5.0600 -0.9200 9.3900 -15.7100 11.2700 -20.3800 -9.7000 -2.4200 3.9700 0.1800 -2.4000 -5.7700 -0.4700 1.3600 2.9800 0.0300 -1.4200 -1.7400 -4.6500 0.7900 14.4700 -5.4300 5.3700 4.8000 3.8700 1.2900 2.9300 1.6600 1.9400 1.8700 1.4300 0.8200 2.2400 1.2800 1.7500 -7.7300 8.3700 8.9300 6.7100 P>z 0.000 0.000 0.484 0.000 0.000 0.243 0.007 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.356 0.000 0.000 0.000 0.000 0.000 0.015 0.000 0.854 0.017 0.000 0.635 0.173 0.003 0.973 0.155 0.082 0.000 0.429 0.000 0.000 0.000 0.000 0.000 0.197 0.003 0.096 0.052 0.061 0.151 0.412 0.025 0.200 0.080 0.000 0.000 0.000 0.000 ME(y=1) -0.0122 0.0117 0.0041 0.0172 -0.0036 0.0011 -0.0037 0.0056 -0.0001 0.0407 0.0008 0.0761 0.0310 0.1557 0.0027 0.0014 -0.0041 0.0204 -0.0042 0.0561 0.0038 0.0019 -0.0034 -0.0002 0.0034 0.0073 0.0003 -0.0008 -0.0060 -0.0001 0.0031 0.0013 0.0043 -0.0005 -0.0042 0.0001 -0.0001 -0.0058 -0.0014 -0.0028 -0.0017 -0.0020 -0.0019 -0.0015 -0.0009 -0.0022 -0.0014 -0.0018 0.0106 -0.0006 -0.0006 -0.0004 ME(y=3) 0.0559 -0.0543 -0.0228 -0.0728 0.0323 -0.0067 0.0338 -0.0298 0.1044 -0.1359 0.1095 -0.2087 0.1884 -0.3363 -0.0213 -0.0085 0.0443 -0.0826 0.0642 -0.1695 -0.0373 -0.0114 0.0191 0.0011 -0.0196 -0.0372 -0.0019 0.0058 0.0315 0.0004 -0.0178 -0.0080 -0.0236 0.0035 0.0612 -0.0004 0.0008 0.0306 0.0100 0.0230 0.0128 0.0148 0.0143 0.0110 0.0062 0.0170 0.0098 0.0133 -0.0500 0.0036 0.0041 0.0027

24

C_SP500_L4 C_Indpro_L1 C_Indpro_L2 Unemp_L1 Irate_3m_L1 Irate_5y_L1 In_L1 In_L2 C_ILI_L1 F_RGDP_L1 F_In_L1 Thresholds 1 2

0.0040 -0.0009 0.0472 -0.1200 -0.0207 0.0613 -0.0104 -0.0034 0.0360 0.0222 -0.0515 -1.0552 -0.9172

0.0010 0.0077 0.0073 0.0067 0.0056 0.0063 0.0015 0.0015 0.0090 0.0038 0.0046 SNP Coefs 1 2 3 4

4.0600 -0.1100 6.4700 -17.8100 -3.6800 9.7700 -6.7500 -2.3100 4.0000 5.9200 -11.1600 -0.0590 -0.0496 0.0291 0.0096

0.000 0.909 0.000 0.000 0.000 0.000 0.000 0.021 0.000 0.000 0.000

-0.0002 0.0001 -0.0029 0.0073 0.0013 -0.0037 0.0006 0.0002 -0.0022 -0.0014 0.0031 Est. Error dist. Variance Skewness Kurtosis

0.0016 -0.0004 0.0189 -0.0480 -0.0083 0.0245 -0.0042 -0.0014 0.0144 0.0089 -0.0206 1.0941 0.4289 3.6017

25

Table 6 Regression Result Business Condition 5y

Variable GoodNewsOnly BadNewsOnly GNWar BNWar GNUnemp BNUnemp GoodGovt PoorGovt BusCond_Better BusCond_Worse EBusCond_Better EBusCond_Worse EPrices_Up EPrices_Down EReal_Income_Up EReal_Income_Down EUnempl_Less EUnempl_More EInt_Rate_Up EInt_Rate_Down Married Divorced Widowed Grade_9_11 High_School Some_College White Black Hispanic Male Age AgeSq Income Recession Irate_5y_L1 C_ICI_L1 C_ICI_L2 C_ICI_L3 C_PMI_L1 C_ILI_L1 C_ILI_L2 C_ILI_L3 C_ILI_L4 F_RGDP_L1 F_Unemp_L1 Thresholds 1 -1.0563 2 -0.7398 Coef. 0.0252 -0.0158 0.0788 -0.0649 0.0566 -0.0385 0.3327 -0.3045 0.1050 -0.2086 0.4208 -0.5734 -0.1446 -0.0762 0.1250 -0.2048 0.1991 -0.4993 -0.1220 -0.0031 0.0359 -0.0233 -0.0051 -0.2979 -0.1495 -0.0342 0.0454 -0.1673 -0.1324 0.2444 -0.0021 0.0000 0.0038 0.0544 0.0020 -0.0289 -0.0164 -0.0229 -0.0014 0.0227 0.0361 0.0316 0.0199 0.0170 -0.1221 Std. Err. 0.0086 0.0111 0.0779 0.0333 0.0179 0.0125 0.0102 0.0097 0.0114 0.0118 0.0100 0.0136 0.0096 0.0203 0.0096 0.0085 0.0105 0.0107 0.0082 0.0103 0.0106 0.0136 0.0183 0.0144 0.0092 0.0094 0.0233 0.0261 0.0284 0.0079 0.0013 0.0000 0.0005 0.0133 0.0020 0.0146 0.0140 0.0143 0.0009 0.0071 0.0071 0.0068 0.0061 0.0029 0.0048 SNP Coefs 1 2 3 z 2.9200 -1.4200 1.0100 -1.9500 3.1600 -3.0800 32.5700 -31.2600 9.2100 -17.7300 42.1100 -42.2400 -15.0100 -3.7500 13.0800 -24.0000 18.8800 -46.5900 -14.8800 -0.3000 3.3800 -1.7100 -0.2800 -20.7400 -16.3300 -3.6300 1.9500 -6.4100 -4.6700 31.0800 -1.5800 2.7200 8.0500 4.1000 1.0000 -1.9900 -1.1700 -1.6100 -1.5500 3.1800 5.0800 4.6400 3.2400 5.9100 -25.5000 -0.0178 -0.0023 0.0066 P>z 0.003 0.155 0.311 0.051 0.002 0.002 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.767 0.001 0.087 0.779 0.000 0.000 0.000 0.051 0.000 0.000 0.000 0.115 0.007 0.000 0.000 0.316 0.047 0.240 0.108 0.122 0.001 0.000 0.000 0.001 0.000 0.000 ME(y=1) -0.0032 0.0020 -0.0087 0.0086 -0.0064 0.0049 -0.0221 0.0495 -0.0111 0.0316 -0.0212 0.1073 0.0143 0.0102 -0.0128 0.0309 -0.0179 0.0906 0.0125 0.0004 -0.0046 0.0029 0.0006 0.0482 0.0215 0.0044 -0.0059 0.0244 0.0187 -0.0200 -0.0001 -0.0005 -0.0062 -0.0002 0.0035 0.0020 0.0028 0.0002 -0.0028 -0.0044 -0.0039 -0.0024 -0.0021 0.0149 Est. Error dist. Variance Skewness Kurtosis ME(y=3) 0.0100 -0.0063 0.0314 -0.0256 0.0225 -0.0152 0.1327 -0.1164 0.0419 -0.0810 0.1671 -0.2073 -0.0578 -0.0300 0.0499 -0.0795 0.0796 -0.1837 -0.0487 -0.0012 0.0142 -0.0092 -0.0020 -0.1140 -0.0585 -0.0135 0.0179 -0.0653 -0.0519 0.0977 0.0004 0.0015 0.0217 0.0008 -0.0115 -0.0065 -0.0091 -0.0006 0.0090 0.0143 0.0125 0.0079 0.0067 -0.0484 0.9926 0.0786 3.0089

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Table 7 Regression Result Buying Condition

Variable GoodNewsOnly BadNewsOnly GNUnemp BNUnemp GoodGovt PoorGovt BusCond_Better BusCond_Worse EBusCond_Better EBusCond_Worse EPrices_Up EPrices_Down EReal_Income_Up EReal_Income_Down EUnempl_Less EUnempl_More EInt_Rate_Up EInt_Rate_Down Married Divorced Widowed Grade_9_11 High_School Some_College White Black Hispanic North_Central Northeast South Male Age AgeSq Income Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Recession C_SP500_L1 C_SP500_L2 C_SP500_L3 C_Indpro_L1 C_Indpro_L2 Unemp_L1 Irate_3m_L1 Coef. 0.0257 -0.0417 0.0957 -0.0427 0.1297 -0.2055 0.1953 -0.2449 0.0189 -0.1518 0.0286 -0.1355 0.0566 -0.1384 -0.0192 -0.1880 0.0200 -0.1014 -0.0125 -0.0431 -0.1357 -0.2246 -0.0009 0.0314 0.1595 0.1038 -0.0242 -0.0005 0.0115 -0.0120 0.1630 -0.0080 0.0001 0.0039 0.1823 0.1313 0.1257 0.1138 0.1338 0.1234 0.1761 0.1285 0.0680 0.0571 0.0320 -0.1969 0.0076 0.0060 0.0041 0.0285 0.0202 -0.1446 -0.0104 Std. Err. 0.0125 0.0149 0.0280 0.0165 0.0152 0.0155 0.0185 0.0241 0.0124 0.0156 0.0137 0.0284 0.0141 0.0132 0.0153 0.0153 0.0117 0.0150 0.0153 0.0193 0.0264 0.0219 0.0130 0.0137 0.0328 0.0361 0.0390 0.0146 0.0157 0.0140 0.0128 0.0019 0.0000 0.0007 0.0260 0.0261 0.0261 0.0252 0.0259 0.0256 0.0266 0.0254 0.0243 0.0245 0.0242 0.0201 0.0012 0.0013 0.0012 0.0090 0.0083 0.0090 0.0070 z 2.0500 -2.8000 3.4100 -2.5900 8.5100 -13.2800 10.5400 -10.1600 1.5200 -9.7400 2.0900 -4.7800 4.0100 -10.4900 -1.2500 -12.2600 1.7100 -6.7600 -0.8200 -2.2400 -5.1400 -10.2500 -0.0700 2.2900 4.8600 2.8800 -0.6200 -0.0400 0.7300 -0.8600 12.7800 -4.2200 3.5400 5.4500 7.0200 5.0300 4.8200 4.5100 5.1700 4.8200 6.6100 5.0700 2.8000 2.3400 1.3200 -9.7900 6.0700 4.6500 3.4200 3.1600 2.4400 -15.9800 -1.5000 P>z 0.041 0.005 0.001 0.010 0.000 0.000 0.000 0.000 0.128 0.000 0.037 0.000 0.000 0.000 0.210 0.000 0.087 0.000 0.414 0.025 0.000 0.000 0.943 0.022 0.000 0.004 0.535 0.970 0.466 0.390 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.005 0.019 0.185 0.000 0.000 0.000 0.001 0.002 0.015 0.000 0.135 ME(y=1) 0.0030 -0.0049 0.0119 -0.0050 0.0164 -0.0222 0.0253 -0.0259 0.0023 -0.0169 0.0034 -0.0152 0.0069 -0.0155 -0.0023 -0.0205 0.0024 -0.0116 -0.0015 -0.0051 -0.0152 -0.0240 -0.0001 0.0038 0.0177 0.0130 -0.0029 -0.0001 0.0014 -0.0014 0.0209 -0.0002 0.0005 0.0200 0.0166 0.0159 0.0143 0.0169 0.0156 0.0227 0.0162 0.0084 0.0070 0.0039 -0.0214 0.0009 0.0007 0.0005 0.0034 0.0024 -0.0173 -0.0012 ME(y=3) 0.0051 -0.0084 0.0185 -0.0086 0.0248 -0.0430 0.0365 -0.0518 0.0037 -0.0314 0.0057 -0.0279 0.0110 -0.0285 -0.0038 -0.0392 0.0040 -0.0207 -0.0025 -0.0086 -0.0279 -0.0473 -0.0002 0.0062 0.0330 0.0200 -0.0048 -0.0001 0.0023 -0.0024 0.0308 -0.0004 0.0008 0.0380 0.0251 0.0240 0.0218 0.0255 0.0236 0.0332 0.0245 0.0132 0.0111 0.0063 -0.0411 0.0015 0.0012 0.0008 0.0057 0.0040 -0.0287 -0.0021

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Irate_5y_L1 In_L1 In_L2 C_ILI_L1 F_RGDP_L1 F_In_L1 Thresholds 1 2

0.0361 -0.0026 -0.0012 0.0099 0.0104 -0.0523 -1.5568 -1.3572

0.0074 0.0018 0.0018 0.0103 0.0045 0.0046 SNP Coefs 1 2 3

4.8900 -1.4500 -0.6600 0.9600 2.3200 -11.4500 0.1406 0.1789 0.0308

0.000 0.146 0.507 0.337 0.020 0.000

0.0043 -0.0003 -0.0001 0.0012 0.0012 -0.0063 Est. Error dist. Variance Skewness Kurtosis

0.0072 -0.0005 -0.0002 0.0020 0.0021 -0.0104 1.6106 -0.0998 2.6621

Table 8 Result of Likelihood Ratio Test

Sentiment Component PerFin_Current PerFin_Expected BusCond_12m BusCond_5y BuyCond * Optimal K selected from K=3 to 6 using AIC and BIC. Order of SNP polynomial () 3 4 4 3 3 Likelihood Ratio Test Statistic 1121.6211 439.3399 296.4618 8.3058 14.8842 p-value 0.00000 0.00000 0.00000 0.00395 0.00011

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Table 9 Explanatory power of the model

Panel I Explanatory power of the full model and each category of variables - Probit model Model All Variables Expectations Personal Characteristics Macroeconomic Variables Forecasts Macro and Forecasts All Variables Expectations Personal Characteristics Macroeconomic Variables Forecasts Macro and Forecasts PerFin_Current 18.085% 11.010% 8.558% 3.299% 0.290% 3.340% 20.764% 13.520% 9.611% 4.291% 0.353% 4.356% PerFin_Expected Full Sample 29.723% 24.938% 8.825% 1.411% 1.555% 2.290% Last 10 Years 30.695% 25.937% 9.611% 2.973% 1.922% 3.044% 58.357% 57.038% 4.298% 14.042% 10.364% 15.296% 46.959% 44.685% 6.754% 3.226% 3.827% 4.374% 15.980% 13.330% 1.699% 7.035% 6.024% 7.798% 55.942% 53.323% 3.230% 14.136% 12.043% 16.730% 41.826% 38.298% 6.002% 2.851% 5.743% 6.086% 16.404% 12.263% 2.323% 7.979% 5.347% 8.677% BusCond_12m BusCond_5y BuyCond

Panel II Explanatory power of the full model and each category of variables - Nonparametric model Model Order of SNP polynomial All Variables Expectations Personal Characteristics Macroeconomic Variables Forecasts Macro and Forecasts PerFin_Current 3 14.696% 5.631% 8.218% 3.553% 0.248% 3.564% PerFin_Expected 4 30.019% 24.038% 3.439% 0.839% 1.505% 2.246% BusCond_12m 4 54.496% 52.366% 0.598% 10.253% 10.274% 10.304% BusCond_5y 3 41.986% 38.431% 3.238% 1.017% 1.847% 2.293% BuyCond 3 18.182% 10.686% 3.496% 11.414% 8.795% 5.599%

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Panel III Incremental explanatory power of each category of variables - Probit model Model Expectations Personal Characteristics Macroeconomic Variables Forecasts Macro and Forecasts Expectations Personal Characteristics Macroeconomic Variables Forecasts Macro and Forecasts PerFin_Current 6.374% 6.540% 0.566% 0.006% 0.589% 7.522% 6.687% 0.529% 0.001% 0.536% PerFin_Expected Full Sample 18.662% 4.355% 0.019% 0.140% 0.625% Last 10 Years 19.247% 4.435% 0.052% 0.014% 0.140% 39.837% 0.303% 0.491% 0.147% 0.977% 36.107% 1.914% 0.135% 0.023% 0.331% 6.963% 0.812% 0.580% 0.211% 1.737% 36.453% 0.432% 0.812% 0.168% 2.103% 30.249% 1.941% 0.020% 0.534% 1.229% 5.726% 1.057% 1.436% 0.133% 2.864% BusCond_12m BusCond_5y BuyCond

Panel IV Incremental explanatory power of each category of variables - Nonparametric model Model Expectations Personal Characteristics Macroeconomic Variables Forecasts Macro and Forecasts PerFin_Current 6.125% 8.916% 0.547% -0.010% 0.567% PerFin_Expected 25.435% 5.825% -0.012% -0.065% 0.405% BusCond_12m 42.416% 0.415% 0.932% -0.035% 1.598% BusCond_5y 30.350% 2.077% 0.026% 0.540% 0.941% BuyCond 9.206% 1.162% 2.057% -0.613% 3.429%

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Figure 1 Index of consumer sentiment in Recent Recession

100

13500

90

13000 80

70 12500

60

50 Jun-04 Jul-05 Aug-06 Sep-07 Oct-08 Nov-09

12000

31

200 180 160 140 120 100 80 60 40 20 0 Jan-78 Jun-79 Mar-80 Apr-81 May-82 Jun-83 Jul-84 Aug-85 Sep-86 Oct-87 Nov-88 Dec-89 Jan-91 Feb-92 Mar-93 Apr-94 May-95 Jun-96 Jul-97 Aug-98 Apr-99 Sep-00 Feb-02 Jul-03 Dec-04 May-06 Oct-07 Mar-09 Sep-99 Oct-00 Nov-01 Dec-02 Jan-04 Feb-05 Mar-06 Apr-07 May-08 Jun-09 14000 13000 12000 11000 10000 9000 8000 7000 6000 5000 4000 14000 13000 12000 11000 10000 9000 8000 7000 6000 5000 4000 Nov-80 Apr-82 Sep-83 Feb-85 Jul-86 Dec-87 May-89 Oct-90 Mar-92 Aug-93 Jan-95 Jun-96 Nov-97 Feb-79 Jan-78

200 180 160 140 120 100 80 60 40 20 0

200 180 160 140 120 100 80 60 40 20 0

Jan-78

Jun-79

Nov-80

Apr-82

Sep-83

Feb-85

Panel I. Index of Consumer Sentiment

Jul-86

Dec-87

May-89

Oct-90

Mar-92

Panel II. Components of Consumer Sentiment: PerFin_Current

Panel III. Components of Consumer Senment: PerFin_Expected

Figure 2 Index of consumer sentiment and its components

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Aug-93

Jan-95

Jun-96

Nov-97

Apr-99

Sep-00

Feb-02

Jul-03

Dec-04

May-06

Oct-07

Mar-09

14000 13000 12000 11000 10000 9000 8000 7000 6000 5000 4000

Panel IV. Components of Consumer Sentiment: BusCond_12m

200 180 160 140 120 100 80 60 40 20 0 Jan-78 Nov-80 Jan-95 Nov-97 Apr-82 Dec-87 Apr-99 Mar-92 Dec-04 May-89 May-06 Mar-09 Aug-93 Sep-83 Oct-90 Sep-00 Oct-07 Feb-85 Feb-02 Jul-86 Jun-79 Jun-96 Jul-03 14000 13000 12000 11000 10000 9000 8000 7000 6000 5000 4000

Panel V. Components of Consumer Sentiment: BusCond_5y

200 180 160 140 120 100 80 60 40 20 0 Jan-78 Nov-80 Jan-95 Nov-97 Apr-82 Dec-87 Apr-99 Dec-04 Sep-83 Oct-90 Sep-00 Mar-92 Oct-07 May-89 May-06 Mar-09 Aug-93 Feb-85 Feb-02 Jul-86 Jun-79 Jun-96 Jul-03 14000 13000 12000 11000 10000 9000 8000 7000 6000 5000 4000

Panel VI. Components of Consumer Sentiment: BuyCond

200 180 160 140 120 100 80 60 40 20 0 Jan-78 Nov-80 Sep-83 Jan-95 Nov-97 Apr-82 Dec-87 Apr-99 Sep-00 Dec-04 Oct-90 Mar-92 Oct-07 May-89 May-06 Mar-09 Aug-93 Feb-85 Feb-02 Jul-86 Jun-79 Jun-96 Jul-03 14000 13000 12000 11000 10000 9000 8000 7000 6000 5000 4000

* Note: In all above figures, the dotted line is Stock and Watson monthly real GDP estimates.

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Figu ure 3 Exp planatory po ower over time t

* Resul lts in this table are a from ordered d probit models.

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Figu ure 4 Bala ance statisti ics for select ted binary independen nt variables s

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36

37

38

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Figu ure 5 Esti imated Erro or Densitie es

Position: PerFin_Curren nt BusCond_12m m BuyCond PerFin_Exp pected BusCond_5 5y

41