News Movers and Shakers In Finance

RavenPack | March 14, 2011

This paper shows that an investor evaluating a universe of stocks should be concerned about tracking media coverage and sentiment.

The concept of abnormal news liquidity is introduced and is demonstrated to predict long-term price direction when distinguishing between companies moving in or out of the media spotlight.

  • Specifically, this paper shows that when companies moving out of the media spotlight are portrayed positively in the news, they tend to outperform the market over the following year.

  • Likewise, companies that are portrayed negatively tend to significantly underperform the market. For companies moving into the media spotlight, the market tends to either over or underreact to positive and negative news sentiment depending on market conditions.

Shakers In Finance

1. Introduction

Besides more traditional quant factors including market capitalization and book-to-market, as initially introduced by Fama and French[Fama & French, 1993], news availability or ”liquidity” may be considered an important dimension when explaining portfolio excess returns.

Normally, news flow is defined as a simple count of stories where a company is mentioned. In contrast, the idea of news liquidity is to capture ”novel” and ”actionable” informational content about companies based on key events - matching a RavenPack category should qualify as actionable.

While, earlier research has examined the link between stock returns, their volatility, and news flows [Zdorovtsov, 2006, Mitchell & Mulherin, 1994], I propose a new approach for measuring public information about companies. In a normal day, a company like ”Apple Inc.” will see a lot of media buzz impacting its news flow. In contrast, news liquidity, as introduced in this paper, would only get impacted by an actual company-specific event e.g.”Steve Jobs resigns from his position as CEO”. News liquidity refers to how much new information is available to investors.

For the constituents of the Russell 3000, Macquarie US Equity Research previously found a correlation of around 55% between news flow and market capitalization1 [Cahan et al., 2009]. Hence, such measures may, to a large extend, capture the same information as market capitalization, thus bringing limited value add to traditional multifactor models. While some companies can be expected to receive greater media attention than others, even on a ”normal” day, news flow and news liquidity may not be adequate measures to capture the likely stock price impact caused by public information. Instead, I propose measuring the abnormal news liquidity to capture changes in media attention and more specifically companies that are moving in or out of the media spotlight.

This study is structured as follows. In Section 2, I describe the concepts of news liquidity and abnormal news liquidity in more detail, and introduce a distinction between companies”ranking-up” and ”ranking-down” in the media spotlight. Furthermore, I define the methodology to construct a company sentiment indicator to capture future systematic drift in stock prices caused by news. In Section 3, I consider how abnormal news liquidity can potentially add value to a risk management process by predicting future levels of volatility. I apply a sentiment overlay to companies ranking up or down by constructing a set of equally weighted Long/Short portfolios with one year investment horizons. Finally, in Section 4, I present the conclusions of the study...

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