Financial market performance in developing economies such as Iran is persistently shaped by the interplay between macro-level uncertainty and investor sentiment. Understanding the roots of stock return variation poses a fundamental challenge: are these fluctuations driven by economic policy ambiguity, or do they arise from herding behavior the collective, emotionally charged chasing of trends and the market’s internal feedback? This study investigates the dynamic relationships among economic policy uncertainty, investor sentiment (proxied by trading turnover as an indicator of emotional behavior), the exchange rate, and stock market returns. We employ monthly time-series data spanning 2007 to 2026 and a vector autoregression approach.

Impulse response functions and variance decompositions reveal that economic policy uncertainty shocks exert no significant and lasting effect on stock returns a finding that may reflect the market’s role as an inflation hedge, preserving asset values amid economic instability. By contrast, exchange rate and investor sentiment shocks generate a positive but short-lived return response that is rapidly absorbed. Causality tests and variance decompositions further indicate that the bulk of return variation is explained by the market’s own internal dynamics, and that a unidirectional causal relationship runs from stock returns to investor sentiment. This confirms the behavioral feedback hypothesis, in which past profitability fuels trader optimism and excitement. Consequently, in the Tehran Stock Exchange, behavioral channels and liquidity flows play a more prominent role than fundamental policy variables in explaining return dynamics.