The limitations of using the confidence index for investor sentiment analysis

B

The Confidence index is the ratio of the average yield on 10 top grade bonds to the Dow Jones average of 40 bonds. The index measures the difference in yield spreads between high-grade bonds and a large cross-section of available bonds. An increase in this index implies that the yield spread between the bonds has narrowed. Now, from a demand perspective, this will happen when the demand for riskier bonds rises. However, the spread could also decrease if the supply of the risky bonds decreases relative to the highgrade bonds. In that case, the change in the confidence index simply reflects the credit needs of the economy and not a change in the risk appetite of investors.